Does formal financial development crowd in informal financing? Evidence from Chinese private enterprises

The relationship between formal and informal finance is uncertain. They serve as substitute for high-quality borrowers but are complement for low-quality borrowers. As formal financial institutions expand, they may concentrate on high-quality borrowers or diversify among borrowers of different qualifies. Using unique survey data from Chinese private firms, we are allowed to investigate the relationship for a group of borrowers who were considered as low-quality. We find that formal financial development imposes a crowd-in effect for private firms' informal financing, especially in East China. There is heterogeneity between East and West China. We document that the crowd-in effect is greater for private firms with bank access or of large size.