Private Firms and Informal Lending in China: Determinants for family and friends lending?

Abstract: China has had an unbelievable economic development over the last 25 years. Their gross domestic product (GDP) has increased by more than 9% yearly. Since the middle of the 1980’s this trend has become more and more dependent on China’s private firms. China’s private firms are much more effective than their counterpart state-owned enterprises. Despite this fact, private firms are still treated very unfairly. They get discriminated against by both the government and individuals. Among other things, this results in private firms having a difficult time finding formal capital to finance their new investments and working capital. A major problem is that the four state-owned commercial banks own most of the assets and they favour the state-owned enterprises. This creates a crowding-out effect against the private firms and also often forces the private firms to seek finance from informal sources. What are other determinants of private firms that force them to lend money from the informal sector? This thesis will test if any of the following determinants: political, economic, risk, relationship and size have any significant impact in the case private firms have to borrow money from family and friends. The different determinants will be represented of chosen proxies that will be tested against a dependent variable in a liner regression. The results show that political connections and the size of the firms make a significant difference in the relationship between private firms having to borrow money from family or friends. Better political connections and larger firms reduce the lending from family and friends. The result from the paper could not establish any significant relationships between informal lending and the determinants risk, economic and relationship variables.