Formal vs Informal Finance: Evidence from China by Meghana Ayyagari, Asli Demirgus-Kunt, Vojislav Maksimovic Discussant Bernard Yeung Stern Mar 2007 2018/11/19

Interesting and important paper First point: China’s use of informal financing is just as extensive as other developing countries, e.g., Brazil, Africa, East European countries, Africa, South Asian 2018/11/19

Interesting and important paper Second point: among all firms (2002 data), or just private firms (not SOE, listed firms): Having bank financing is positively and significantly associated with sales growth, percent profits reinvested, and, not related with productivity Self-financing (informal, family, other) is Not related with sales growth, Possibly negative related to reinvestment Positively and significantly associated with productivity growth Productivity is (sales – total material costs)/L Control for Endogeneity in treatment effects City, size, firm type, age, competition Contribution – Use large scale data to show that formal (bank) financing helps growth and reinvestment 2018/11/19

Comment on “endogeneity” Correlation between getting loans and future profitability, a classic problem Use a treatment effects model, Heckman correction (Inverse Mill’s Ratio) 2018/11/19

Endogeneity Need an instrument to predict getting bank loans but not correlated with future performance Collateral dummy as = 1 if has a loan and put in a collateral = 0 if has a loan, no collateral requirement, no loan because can’t put in a collateral, do not apply for a loan b/c no collateral. The dummy captures the intersection of “requirement” for and “ability” to put in a collateral Logic: “Collateral serves as a proxy for the firm’s ability to post collateral. (so, can get a bank loan). Whether there was a collateral requirement or not is less likely to be correlated with firm’s growth and hence need not enter the 2nd stage. Thus collateral serves as the identifying variable in our selection equation.” Curiosity That some are granted a bank loan but not required a collateral are possibly due to their expected future performance But would that not make a part of the dummy correlated with future performance? Feel weird to use ex post variable to as an ex ante “predictor”, but not very successful to pinning down what is ‘wrong” Why not use “tangibility” as an instrument? 2018/11/19

Why the research is important? Does finance matter? Certainly With finance, growth, no doubt Why interested? Allocation efficiency is the key Reinterpret With bank loan, experiences sales growth, reinvest more, but, VA/L does not increase! Meaning? Self-financing, experiences little sales growth, little increase in reinvestment, but VA/L grows! Efficient/Inefficient formal external financing?! 2018/11/19

Why banks are inefficient? Corporate governance Who own banks? Managers are by political appointment Lack of prudent judiciary duties Connected lending (short termism in the G) Opaque system  corruption, NPL Poor internal corporate governance Credit officers want to lend! My promotion vs. protecting other people’s money Bank monitoring of borrower? Go hard = face against connections 2018/11/19

Push Examine the efficiency of the system Dig into the regions and cities and ask: where bank lending leads to better results? Link the efficiency of bank financing with a region/city’s institutional environment? Quality of the government Quality of the regulations and supervision? Quality of bank executives? Bank’s credit policies – equity requirement, credit reports, etc Loan officers’ incentive/agency problem? 2018/11/19

Still puzzled Recall the first point: China’s use of informal financing is just as extensive as other developing countries, e.g., Brazil, Africa, East European countries, Africa, South Asian But, efficiency? Raise the puzzle: why is China growing so fast – even with its lousy capital markets? Higher savings? China’s capital allocation is a bit more efficient, at least in some major cities? Using location level variables to shed light? 2018/11/19

Conclude Interesting paper leading to interesting questions 2018/11/19