The coexistence of formal and informal finance: New evidence from the use of trade finance by farmers in Chile

We have analyzed whether formal and informal finance are substitutes or complements, using hand-collected survey data on the use of formal and informal finance of 177 Chilean farmers producing fruits and vegetables for the years 2005-2006 and 2007-2008. Our data reveal that formal bank loans are the most important source of external finance. Yet, a substantial part of the farmers (48 per cent) also uses trade financing. We find evidence suggesting that access to bank loans and the use of trade finance are negatively associated. This relationship is strongest for trade credit. For advanced payments we are unable to find statistically significant evidence for a such a relationship. Our findings may hold lessons for policies focusing on developing domestic financial markets. Increasing access to bank loans may not reduce, let alone abolish the use of informal sources of finance. Formal and informal finance remain being important and needed to improve the performance of entrepreneurship. Although we did not explicitly investigate this, formal and informal finance may partly finance different activities. Yet, if access to formal finance is not sufficient, borrowers may revert to informal finance to fill the gap.