Capital Flows and Fragmented Credit Markets in
Latin America
Pablo Duarte∗
January 26, 2015
Abstract
The Latin American financial sector is fragmented in a formal and an
informal segment. International capital flows may affect the segmentation
through its influence on credit supply and interest rates. I examine the effect
of the buoyant capital inflows in the region between 2006 and 2010 on the
relative usage of informal financing sources by firms of 18 Latin American
countries. I focus on the role legal-institutional barriers play on amplifying or
dampening the effect. I find that capital inflows are related to a lower usage
of informal sources of finance. Lower banking concentration – a supply side
institutional barrier – as well as lower costs to start firms and a more equal
protection of property rights – demand side institutional barriers – amplify
the effect.
Keywords: informal finance, banking concentration, capital flows.
JEL Codes: G21, K42, O17
∗
Institute for Economic Policy; University of Leipzig; Grimmaische Str. 12; 04109 Leipzig;
Germany; Email: pablo.duarte@uni-leipzig.de.
1
1
Introduction
Informal markets are a widespread phenomenon in Latin America. At informal
markets people exchange legal goods and services without fulfilling the formal
conditions required in a jurisdiction. Examples are houses without building permits,
food without fulfilling sanitary regulation or credit without fulfilling financial
requisites as transaction taxes or interest rate caps.1
Informal markets for credit are the most important source of finance for
microenterprises and a non-negligible source of finance for medium size firms in
Latin America (CAF, 2011). Formal financial intermediaries need a bank license to
operate, have to comply with reserve requirements at the central bank and in some
countries must collect financial transactions taxes and observe interest rate caps.
At informal credit markets transactions are done without a bank license, without
having reserve requirements at the central bank, without paying taxes or at interest
rates without restrictions. The most common informal financing sources in Latin
America are family members, private lenders, pawn shops and alike (CAF, 2011,
196).
Capital flows may have different effects on the relative usage of formal vs.
informal financing sources. With buoyant capital inflows, as it has been the case in
Latin America since 2006 and more strongly since the zero interest rate policy of
the Federal Reserve after 2008, the loanable funds at formal markets increase. Such
increase in formal credit supply might have different effects. On the one had it might
ease access to formal credit and thus increase the relative use of formal finance.
On the other hand, it might lower formal interest rates and motivate arbitrage
movements to the informal credit markets. After discussing some theoretical issues
I examine the effect of capital flows on the relative usage of informal finance for 18
Latin American countries.
1
Transactions of (in Latin America) illegal goods as cocaine or illegal “services” as hired killing
are not considered when studying informal markets. For a deeper discussion on the definition of
informality see Schneider and Enste (2000).
2
Since the 1970s Latin America has experienced four phases of buoyant capital
inflows.
The resulting boom-and-bust-cycles haven been intensively studied.
Reinhart et al. (1994), for instance, compare the B&B cycles of the 1970s and the
1990s. Calvo et al. (1996) analyse the macroeconomic effectiveness of the different
economic policy reactions of capital inflows in Latin America and South East Asia.
Ocampo (2009) und Jara et al. (2009) examine the macroeconomic effects of the
most recent global financial crises in Latin America. De Paula et al. (2012) examines
the macroeconomic consequences of the regions’ actual ”Capital-Bonanza”. Gómez
et al. (2014) examine the connection between capital debt flows and the local credit
market in Colombia. They find that a negative shock international debt flows
has a negative effect on the proportion of firms having access to (formal) financial
intermediation. They also find that in the long-run capital flows and the growth of
domestic (formal) credit are positively correlated. To my best knowledge, however,
there are no studies which examine the effect of capital flows specifically taking to
account the fragmentation of the credit markets in Latin America.
The contributions of the paper are twofold. First, I identify three characteristics
of the legal-institutional framework that motivate informal financial transactions
and second, I shed a light on the effects of capital inflows on the use of informal
financial sources and the role the legal-institutional barriers play in the scenario of
buoyant capital inflows which the regions experiences since 2006.
2
Institutional determinants of informal financial transactions
To understand the characteristics of the legal-institutional barriers which motivate
people to supply and demand capital at informal rather than formal markets, it is
useful to think about the characteristics of an ideal market. The essence of markets
is to be found in its nature of a competitive order in which individuals voluntarily
exchange as legal equals (Vanberg, 2004, 9). The fact that individuals meet as
legal equals implies that the rules under which exchange takes place do not grant
3
privileges to any market participant and that free entry to the market is possible.
Only under such condition of law equality, the market price system can fulfill its
function as a coordination mechanism for individual plans (Böhm, 1966, 121).
In an ideal financial market anyone with a sound project can access the financial
market and “it will be the quality of the underlying assets or ideas that will
determine whether finance is forthcoming, and the identity of the owner (...) will
be irrelevant” (Rajan and Zingales, 2003, 9). Said differently, if N is the total
number of entrepreneurs in a jurisdiction and θN , with 0 ≤ θ ≤ 1, the number of
entrepreneurs who have access to finance, an ideal financial system would require
that θ = 1.
Informal finance is mainly understood as the response of creditors and borrowers
to imperfect financial sectors and state interventions (Burkett, 1988). Imperfections
are present when θ < 1, as the excluded individuals would have incentives to evade
regulation and supply and demand capital informally. There are mainly three
structural barriers which reflect a low θ in Latin America. The barriers can be
classified as supply and demand side barriers.
2.1
The credit supply channel
High entry barriers for credit suppliers, specially at the banking sector, might
motivate informal financial transactions in two ways. First, they exclude potential
creditors from the legal possibility of supplying capital. Second, entry barriers lead
to bank concentration and market power of incumbent banks, what hardens access
to finance for entrepreneurs. High entry barriers for banks and thus a low θ create
incentives for excluded entrepreneurs and capital owners to trade informally.
Beck et al. (2004) and Love and Peria (2012) study the role of banking
concentration and banking competition on access to finance. Both studies suggest
that market concentration increases firm-reported financing obstacles and reduces
actual access to finance. Beck et al. (2004) find that higher bank concentration
4
leads to more firm-reported obstacles to finance for firms of all sizes in a cross
section of 74 countries. The relation, however, holds only for low-income countries
and is dampened by the level of institutional development measured as the average
of six indicators.2 In the same sense, Love and Peria (2012) find that high bank
competition, represented by a low Lerner index, facilitates access to finance and
that higher financial development, measured by the ratio of private credit to GDP,
reduces the effect of lower banking competition on financial access.
2.2
The credit demand channels
Entry barriers for entrepreneurs and an unequal enforcement of property rights are
the barriers at the capital demand side of credit markets.
When entrepreneurs face high start-up costs at the formal sector, they often
decide to produce informally. As informal producers do not appear in the public
registries and usually do not register their own operations, do not use identifiable
payment mechanisms such as banking accounts and do not properly separate the
firm’s from the individual’s capital (Straub, 2005, p. 301), the screening costs for
formal credit lenders are prohibitively high. Entry barriers to the formal economy
lower the value of θ as informal producers can not provide formal banks with the
necessary information. Informal firms are therefore usually excluded from the credit
markets, even if they have a sound investment project.
Djankov et al. (2002), for example, find that higher regulation of entry, measured
as the number of procedures, the costs as percentage of GNI per capita and the time
procedures take to start a business, are positively related with the size of the informal
sector in a cross-section of 85 countries as measured by Schneider and Enste (2000).
The second demand side characteristic which reflects a low θ is the unequal
enforcement of property rights. Formal credit suppliers normally use a collateral
2
The index of institutional development summarizes variables for voice and accountability,
political stability and absence of violence, government effectiveness, regulatory quality, rule of law
and control of corruption from the World Governance Indicators(WGI). See Kaufmann et al. (2009)
for the newest version of the WGI.
5
to overcome information problems and to secure repayment. Borrowers, however,
cannot use assets as collateral if the assets are not protected by a property rights
system. De Soto (2000) calls this kind of assets “dead capital”. The lack of a
collateral, that is a legally protected and registered asset, excludes the potential
borrower from the formal financial sector. In that sense, the less equal the protection
of property rights in a jurisdiction, the lower is the value of θ.
Informal producers and entrepreneurs owning dead capital are likely to recur
to informal financial institutions as informal lenders have monitoring comparative
advantages against formal ones.
The comparative advantages rely on the
enforcements and monitoring mechanisms informal credit suppliers use, which are
more accurate given the lack of official registries and accurate collateral (Ayyagari
et al., 2010; Arnott and Stiglitz, 1991; Stiglitz, 1990). Specifically in Latin America,
the enforcement and monitoring mechanisms often rely on violence and physical
threat (CAF, 2011, p. 196) and are based on the access to local information, only
available to informal lenders because of their social and physical proximity to the
borrower.3
3
The reaction of informal credit markets to capital inflows
Figure 1 shows the relationship between formal and informal credit sources for the
18 Latin American countries. In all countries is the percentage of credits from
informal sources more than 50% of total finance from external sources with Mexico
with almost 76% and Honduras with 51%.
With a higher supply of formal and informal capital and lower interest rates
due to buoyant capital inflows, entrepreneurs face new possibilities at the credit
markets. Given that the conditions for formal credit (interest rates and repayment
3
“The following story, told by the president of the Paraguayan association of finance companies,
describes the kind of enforcement usurers favor: One of our clients was heavily indebted with several
creditors, including us and a usurer. As a way to remind him of his obligation, the usurer sent him
a bullet in an envelope. The client paid the usurer first and then filed a reorganization procedure.
We recovered only a small fraction of the formal loans.” (Straub and Sosa, 2001, p. 296).
6
Figure 1: Finance of Working Capital by External Sources (2010)
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Informal
Bank
Source: Enterprise Surveys, The World Bank.
enforcement mechanisms) are typically more advantageous than for informal credit,
the additional availability of capital from formal sources may motivate a different
rearrangement of the firm’s capital sources. The rearrangement, however, depends
on whether formal and informal credit suppliers compete with each other for the
same customers or the informal lenders enhance the formal lenders (mainly banks)
in a different market.
3.1
Formal and informal credit sources as competitors
Specially when credit supply side barriers predominate, informal credit suppliers
tend to compete with established formal ones. That means, informal and formal
credit suppliers have the same potential clients.
The entry barriers for credit
suppliers, as discussed in section two, keep formal credit supply constrained. As
credit constrains are eased with the additional availability of loanable funds due to
the international inflow of capital, firms have more possibilities of getting formal
financing. They would substitute informal for formal credits, as far as the credit
barriers allow to. Therefore, the relative usage of informal finance as percentage
of total external finance would decrease. The credit supply and demand barriers
7
identified in section 2 may dampen or amplify the effect.
On the credit supply side, high bank concentration dampens the effect of capital
inflows on the usage of informal finance. Banking concentration hinders the increase
of the supply of capital at the formal sector and the lowering of interest rates
impulsed by the increasing international capital. If informal credit sources are
mainly an alternative for entrepreneurs when formal sources are not available, the
usage of informal sources will not decrease as much as if the levels of banking
concentration were low. If informal credit sources are mainly a complement for
formal financial markets, the difference between the formal and informal interest
rates will not be as high as without entry barriers for banks, less capital will flow
in the informal financial markets and the relative usage of informal finance will not
decrease as much.
Following the same logic, credit demand side barriers are also expected to
dampen the reduction in the relative usage of informal credit sources. The higher
the start-up costs for entrepreneurs, the higher is the probability that entrepreneurs
act informally and the more difficult it would be for them to change from informal
to formal finance. In the same sense, the more deficient the protection of property
rights, which determines the portion of “dead capital”, the more difficult it is for
firms to substitute informal for formal credit.
3.2
Informal lenders enhance formal lenders (banks)
When credit demand barriers predominate, formal and informal credit suppliers
do not have the same potential clients. Informal credit suppliers work as informal
“branches” of banks transmitting the new international capital to the entrepreneurs
without access to the formal financial sector. Additional availability of loanable
funds due to international capital inflows would increase the relative usage of
informal sources of finance, as individuals cannot easily change to formal credit
sources.
8
Following the same logic as above, the credit supply barriers dampen the increase
of the relative usage of informal credit sources. The interest rate differential, which
motivates arbitrage movements and increases the loanable funds for informal sources,
would be smaller the higher the bank concentration. Less credit is available at the
informal financial credit markets and the increase in its relative usage is less than
in cases with low bank concentration.
The credit demand barriers would amplify the increase in the relative usage of
financial credit sources. The higher the star-up costs for entrepreneurs and the
higher the unequal protection of property rights, the more important are informal
credit sources for financing working capital. The percentage of total external finance
from informal sources would increase with additional capital availability principally
because credit financing would increase, and informal sources are the most likely
alternative in the case in which formal and informal lenders are complementary.
Summing up, one might expect that the effect of capital inflows on the relative
usage of informal credit source depends on the relationship between formal and
informal lenders. If they are competitors, the usage of informal credit sources is
expected to decline with capital inflows. If informal lenders enhance formal lenders,
the relative usage of informal finance is expected to increase. The credit supply
and demand side barriers identified in section 2 may dampen or amplify the effects.
Bank concentration – the credit demand side barrier – dampens both, the reduction
of the usage of informal sources in the competition case and the increase in the
non-competition case. The supply side barriers dampen the decrease of usage of
informal sources in the competition case and amplify the increase in informal credit
in the non-competition case.
9
4
Empirical Evidence
4.1
Data and model
I test for the effects of capital inflows on the usage of informal capital sources
by entrepreneurs for 18 Latin American countries (see Table 1). I use micro and
macroeconomic data. All the microeconomic data is at a firm-level and is provided
by the Enterprise Surveys published by the World Bank. The Enterprise Surveys
report the answers of over 12,000 formally registered firms in the 18 Latin American
countries of the sample about, among others, their financing sources for working
capital as percentage of total finance. I use data of year 2010 for all countries
excepting Brazil, for which data is available for 2009. I therefore use data of year
2009 for Brazil. The baseline regression is:
inf ormalf inance
= β0 + β1 Kinf lowsj + β2 (1 − θ1 ) + β3 Kinf lows × (1 − θ1 )+
totalf inance i,j
β4 (1 − θ2 ) + β5 Kinf lows × (1 − θ2 ) + β6 θ3 + β7 Kinf lows × θ3 + β8 Xj + β9 Zi,j .
For the endogenous variable
inf ormalf inance
totalf inance i,j
(wk inf ormal) I constructed three
categories given the available information: formal, informal and own. The sum of
the three categories equals 100. Informal financial sources include family and friends,
supplier credit / customer advance, informal sources, other sources and remittances.
The endogenous variable is expressed as percentage of total finance.
The three θi variables capture the three institutional barriers which motivate
informal financial transactions identified in section 2. The variable (1-θ1 ) is captured
by a bank concentration index (concent), which captures the assets of the five
largest banks as a share of the total commercial banking assets and by a Lerner
index (lerner). Both measures are provided by the Global Development Financial
Database published by the World Bank. Three indexes provided by the Doing
Business database of the World Bank capture (1-θ2 ). These are the costs, steps and
days required in each country to start a business. θ3 is captured by the property
10
rights protection index provided by the Index of Economic Freedom (p rights). All
values are at a national level for the year 2010 and 2009 for Brazil.
The variable kinf lows sum captures the sum of net capital inflows from 2006
to 2010 as percent of GDP for each country. The net capital inflows are defined as
the current account deficit reported by the balance of payments statistics of each
country in each year. The sum is done from 2006 to 2010 because on average, in the
year 2006 began the most recent phase of capital inflows in the region. The data is
from the International Financial Statistics (IFS) published by the IMF. The baseline
regression also includes an interaction term of θi with kinf lows sum which intends
to capture the effect of capital inflows on the relative usage of informal finance due
to the interaction with each θi index.
The vector Xj includes two control variables at a national level. These are:
logarithm of GDP per capita in 2010 (lgdpp c), which controls for the overall
development level of each country; inf lation, which controls for the financial
stability of each country. The vector Zi,j includes control variables at a firm level.
These are: size, which takes the value of 1 if the firm has less than 20 employees,
2 if it has between 20 and 99 employees and 3 if it has more than 100 employees;
inf ormal ini which takes the value of 1 if the firm was officially registered in the
year it began operations. The variable is intended to capture the “legal maturity”
of the firm. Firms which were registered at the beginning of their operations are
less likely to use informal financing sources; inf ormal, provided by the Enterprise
Survey, takes the value of 1 if the firm assures to compete against informal firms
in the market and 0 otherwise. inf ormal intends to control for the portion of the
firms which are not part of the survey and are likely to use informal finance.
Table 1 shows the descriptive statistics of the variables. On average, the firms
financed 26.44 % of their working capital from informal sources. In Colombia the
average percentage of total finance coming from informal sources is the highest with
almost 41% compared with 7.5% for Panama. The country which received the
11
12
wk inf ormal
30.05
21.22
25.34
26.06
40.85
13.58
29.57
31.81
31.27
28.36
14.84
29.23
11.52
7.50
21.69
28.97
23.57
27.28
26.44
country
Argentina
Bolivia
Brazil
Chile
Colombia
Costa Rica
Dom. Rep.
Ecuador
El Salvador
Guatemala
Honduras
Mexico
Nicaragua
Panama
Paraguay
Peru
Uruguay
Venezuela
Total
5.26
-10.53
-42.62
0.25
-8.99
12.80
25.63
32.25
-8.35
21.50
16.06
36.31
5.09
62.63
32.89
-11.06
2.62
11.78
-35.21
kinf lows sum
73.13
52.97
79.43
65.99
.
67.59
75.60
86.45
72.88
83.60
79.82
69.38
71.21
100.00
72.50
70.94
88.38
73.79
85.20
0.24
0.30
0.27
0.23
0.31
0.37
0.15
0.16
0.17
0.35
.
0.19
.
.
0.31
0.03
0.38
-0.18
0.31
concent lerner
24.72
16.90
100.80
6.90
6.80
14.70
10.50
19.20
32.60
45.00
49.10
47.20
12.30
111.90
10.30
55.10
13.60
42.10
30.20
costs
26
50
119
22
14
60
19
56
17
37
14
9
39
9
35
27
65
141
days
10.24 44.33
14
15
14
8
9
12
8
13
8
12
13
6
8
6
7
6
11
17
steps
Table 1: Descriptive Statistics
43.93
20
10
50
85
50
50
30
20
50
35
30
50
25
40
30
40
75
0
p rights
8.48
8.74
7.07
8.57
9.06
9.06
8.59
8.47
8.09
7.99
7.73
7.32
9.00
7.13
8.75
7.45
8.25
8.83
8.70
lgdp pc
25.40
38.77
31.26
14.88
21.44
20.33
41.26
26.67
20.78
13.85
25.80
31.53
19.88
45.65
20.59
27.83
12.55
33.27
76.66
inf lation
1.91
1.99
1.91
1.83
2.03
1.91
1.86
1.99
1.92
1.98
1.94
1.68
2.00
1.71
1.85
1.85
1.99
1.85
1.65
size
0.90
0.92
0.87
0.95
0.94
0.84
0.77
0.83
0.87
0.77
0.89
0.87
0.90
0.79
0.99
0.98
0.92
0.95
0.97
inf ormal ini
0.67
0.71
0.80
0.66
0.53
0.76
0.73
0.73
0.64
0.67
0.73
0.59
0.65
0.66
0.59
0.75
0.73
0.73
0.36
inf ormal
13
wk inf ormal
kinf lows sum
concent
lerner
costs
steps
days
p rights
lgdp pc
inf lation
size
inf ormal ini
inf ormal
1
-0.07
-0.05
0.09
-0.07
-0.02
-0.04
0.01
0.09
-0.06
-0.02
0.00
0.04
wk inf ormal
1
0.35
-0.15
0.14
-0.35
-0.28
0.13
-0.16
-0.09
-0.03
-0.10
0.03
kinf lows sum
1
0.04
0.47
-0.41
-0.09
-0.07
-0.47
0.05
-0.02
-0.06
-0.01
1
-0.33
-0.19
-0.26
-0.19
0.13
-0.23
0.04
-0.03
-0.03
concent lerner
1
0.13
-0.07
-0.43
-0.81
0.37
-0.04
-0.06
0.04
1
0.71
-0.39
-0.19
0.44
-0.06
0.02
-0.01
costs steps
1
-0.08
-0.06
0.16
-0.07
0.06
-0.04
days
1
0.54
-0.47
0.04
0.02
-0.03
1
-0.14
0.05
0.04
-0.04
1
-0.06
-0.02
-0.05
p rights lgdp pc inf lation
Table 2: Correlation Table
1
0.11
-0.11
size
1
-0.09
inf ormal ini
1.00
inf ormal
highest capital inflows (net) between 2006 and 2010 was Nicaragua with 62.7% of
GDP and the country with the highest capital outflows was Bolivia with 42.62 %
of GDP. The concentration and lerner indexes show that the banking sector of the
region is highly concentrated. This is the result of a consolidation and concentration
process which took place in the last decade (Chortareas et al., 2012; de la Torre et al.,
2012; Rojas-Lopez, 2006). On average, the surveyed firms have between 20 and 99
employees. Table 2 shows the correlation coefficients of the variables.
4.2
Results
As explained in section 3.1, the accumulated capital inflows can have a direct effect
on banking concentration. Table 3 shows the results for the baseline regression using
the different variable for θi . In all specifications, in countries with higher capital
inflows as percent of GDP informal financial sources were less used. This negative
and significant effect implies in a scenario with additional capital available at lower
interest rates, firms decide to finance a lower portion of their working capital from
informal sources.
The θ variables have a different effect on the endogenous variable.
Using
the Lerner Index for banking concentration (first three columns of table 3), a
higher banking concentration induces a higher financing from informal sources in
specifications 1 and 2, as argued in section 2. In both specifications Lerner is positive
and statistically significant. The interaction term is negative in the three cases and
statistically significant. This implies that the θ1 values amplify the negative effect
of capital inflows. Adding the size of the coefficients of lerner, kinf lowssum and the
interaction term, the overall effect is positive. Despite the capital inflows, a high
banking competition still motivates firms to finance working capital from informal
sources. This implications do not hold when using Days as the variable capturing
θ2 .
Using concentration (columns 4, 5 and 6) the results are similar, but not
14
Table 3: Baseline Regression (OLS)
(1)
wk informal
-0.143
(-1.56)
(2)
wk informal
-1.006***
(-7.60)
(3)
wk informal
-0.102
(-1.22)
(4)
wk informal
-0.294***
(-2.65)
(5)
wk informal
-1.003***
(-7.95)
(6)
wk informal
-0.144**
(-2.05)
informal
3.229***
(4.62)
2.786***
(3.96)
3.082***
(4.35)
3.011***
(4.44)
2.824***
(4.18)
3.045***
(4.50)
size
-1.653***
(-3.98)
-1.624***
(-3.88)
-1.676***
(-3.99)
-1.374***
(-3.46)
-1.476***
(-3.72)
-1.457***
(-3.68)
-0.981
(-0.88)
-1.065
(-0.95)
-1.299
(-1.16)
-0.485
(-0.47)
-0.173
(-0.17)
-0.611
(-0.60)
inflation
-0.484***
(-10.57)
-0.330***
(-7.35)
-0.428***
(-8.94)
-0.387***
(-7.41)
-0.338***
(-7.65)
-0.224***
(-5.11)
lgdp pc
18.63***
(13.45)
11.14***
(12.00)
10.54***
(11.85)
11.74***
(8.77)
9.284***
(10.95)
2.447***
(2.63)
lerner
18.97***
(5.20)
9.822***
(2.77)
-6.045
(-1.60)
lerner X Kinflows sum
-0.699**
(-2.54)
-0.559*
(-1.93)
-0.380
(-1.37)
costs
0.404***
(11.09)
0.118***
(4.24)
0.00713***
(10.03)
0.00121*
(1.90)
Kinflows sum
informal ini
costs X Kinflows sum
p rights
-0.244***
(-9.03)
-0.243***
(-7.94)
-0.168***
(-6.54)
-0.199***
(-5.89)
-0.321***
(-7.74)
0.0769*
(1.81)
p rights X Kinflows sum
0.000155
(0.09)
0.00955***
(5.99)
0.00285**
(2.22)
0.00367
(1.13)
0.0124***
(4.51)
0.00363
(1.41)
steps
-0.690***
(-4.66)
0.107
(0.79)
steps X Kinflows sum
0.0603***
(7.70)
0.0482***
(7.00)
days
-0.0666***
(-6.54)
-0.0621***
(-6.28)
days X Kinflows sum
-0.00209***
(-3.27)
-0.00594***
(-6.66)
concent
con f X Kinflows sum
cons
N
R2
adj. R2
AIC
-119.6***
(-10.47)
9420
0.040
0.039
91667.4
-41.45***
(-6.51)
9420
0.029
0.028
91770.4
t statistics in parentheses
* p < 0.10, ** p < 0.05, *** p < 0.01
15
-38.18***
(-6.14)
9420
0.028
0.027
91779.5
0.0444
(1.08)
0.203***
(4.23)
-0.0643
(-1.40)
0.00437*
(1.94)
0.0128***
(6.05)
0.0183***
(7.06)
-59.52***
(-4.60)
10782
0.029
0.028
105471.7
-44.87***
(-4.55)
10782
0.030
0.029
105459.3
17.67*
(1.81)
10782
0.032
0.031
105438.8
identical.
The accumulated capital inflows have a negative and statistically
significant coefficient.
Contrary to the lerner index, the interaction terms are
positive and statistically significant. The size of the coefficients are, however, much
smaller compared to the effect of the lerner index. The difference reflects that the
information captured in each variable is different. The correlation coefficient between
lerner and concent is 0.04 (table 2). The lerner index captures the possibility banks
have on setting a price above the marginal costs while the concentration index
focuses on the assets owned by the five biggest banks. The concentration measure,
however, does not necessarily imply a higher market power of the incumbents. For
that reason, the Lerner index might be a more accurate measure (Love and Peria,
2012).
The variables capturing θ2 , that is the costs to start a firm, show a similar
behavior. Higher costs in terms of GDP imply a higher use of informal finance. The
interaction term is also positive and the coefficient is insignificantly small. Steps
and days show contradictory effects. In this case the variable also captures different
information. Table 1 shows, for example, that in Brazil 119 days are needed for 14
steps to start a firm. In Bolivia, one step more is needed, but the firm can be started
in less than the half of the days needed in Brazil (50). The costs in Brazil in terms
of per capita income are much lower than in Bolivia. In this case, the start-up costs
as percent of per capita income is the most objective and comparable variable.
Finally, the Property rights index (θ3 ) is in all minus one specification negative
and statistically significant. This implies that a better and more equal protection
of property rights induce firms to finance a lower portion of their working capital
from informal sources. The interaction term is always positive, but very small and
its influence insignificant.
The dependent variable of the regression kinf lowssum can only take the values
between 0 and 100. That means that it is censored at an upper and a lower limit
and that the coefficients of the baseline regression might be biased. Table 4 shows
16
Table 4: Tobit Regression
(1)
wk inf ormal
model
kinf lows sum
-0.179**
(-2.37)
inf ormal (d)
3.297***
(4.80)
size
-0.309
(-0.74)
inf ormal ini (d)
-0.796
(-0.71)
inf lation
-0.604***
(-12.74)
lgdp pc
23.80***
(16.48)
lerner
23.95***
(6.33)
lerner × kinf lows sum
-1.582***
(-5.24)
costs
0.551***
(14.22)
costs × kinf lows sum
0.00719***
(9.14)
p rights
-0.340***
(-11.97)
p rights × kinf lows sum
-0.00425**
(-2.57)
9420
Observations
R2
Adjusted R2
AIC
57420.9
Marginal effects; t statistics in parentheses
(d) for discrete change of dummy variable from 0 to 1
* p < 0.10, ** p < 0.05, *** p < 0.01
17
the results for a Tobit-regression using only the Lerner index and the start-up costs
as percent of per capita national income. The accumulated capital inflows have a
negative and statistically significant effect. Such effect is amplified by the interaction
of the capital inflows with the banking concentration index. That implies, that in
countries with a higher baking concentration, incoming international capital will
have an even higher effect on the reduction of informal finance. The overall effect is
however positive, as the coefficient of the lerner index is much bigger than the sum
of the coefficients of the capital inflows and the interaction term.
Higher start-up costs lead to more usage of informal finance and the interaction
term with capital inflows is insignificantly small. A better protection of property
rights is related to a lower usage of informal sources to finance working capital and
its interaction with kinf lowssum is also insignificantly small.
5
Conclusions
I examine the effect of capital inflows on firms’ usage of informal financing sources
in 18 Latin American countries. Latin American entrepreneurs without access to
formal financial markets demand and supply capital informally, that is without
fulfilling the legal regulation of each jurisdiction. In a perfect financial system, any
entrepreneur with a sound investment project could access finance irrespective of
her identity.
I identify three barriers which interfere with the perfect functioning of financial
markets in Latin America and makes it more difficult for entrepreneurs with sound
projects to access finance. Banking concentration, a supply side barrier, leads to
lower credit supply and financing obstacles for entrepreneurs. Entry barriers for
firms and an unequal protection of property rights are credit supply side barriers.
The barriers lead to an imperfect overcoming of information problems which hardens
credit transactions at the formal financial sector and motivate informal financial
transactions.
18
With international capital inflows, more capital is available, first at the formal
financial sector. The additional capital lowers interest rates at the formal markets.
This might have two effects which depend on the relationship between the formal
and the informal financial markets. If both are complements, the usage of informal
finance might increase as the difference between the higher informal interest rates
and the formal interest rates increase, motivating arbitrage movements between the
two markets. If the markets are substitutes, the lower interest rates and easier credit
constrains would motivate individuals to turn to the formal financial markets.
Using data from the Enterprise Surveys published by the World Bank, and
national macroeconomic data, I find that capital inflows induce a reduction of firms’
usage of informal sources to finance working capital. I additional find that banking
concentration, the credit demand barrier which induces the usage of informal finance,
increases the financing from informal sources and that it dampens the reduction of
informal finance by the capital inflows. I also find that the costs to start a firm, the
first credit supply side barrier, increase the usage of informal finance and that the
interaction term with capital inflows is insignificantly small. A more equal protection
of property rights, the second credit supply side barrier, reduces the financing from
informal sources and it neither dampens nor amplifies the effect of the capital inflows.
In a scenario of “capital bonanza”, the access to finance improves. Entrepreneurs
seem to decide to use less informal sources to finance their working capital. Financial
markets are still imperfect. If the goal of policy makers is to improve financial
development in Latin American countries they would not only have the openness to
international financial markets as an option. By reducing baking concentration,
reducing start-up costs and improving the equal protection of property rights,
and this way following the ideal of a privilege free order of legal equals, reforms
could allow entrepreneurs to access formal finance and benefit from the financing
possibilities of phases of buoyant capital inflows.
19
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