Borrowing amongst friends: the economics of informal credit in rural China

Purpose - The purpose of this paper is to investigate the economic significance of informal borrowing between friends and relatives in rural China. Guided by an economic model of household‐production interactions, the paper provides results from a survey of over 1,500 households including general linear model and logistic regression results. The paper finds evidence of a “small farm bias” in the use of informal credit, but the paper cannot generalize this to credit rationing as a matter of course. In part, it is believed that a preference for informal borrowing is related to some forms of credit rationing, spillover effects and collateral as some literature suggests, but the results suggest that by no means are these mutually exclusive or exhaustive. Design/methodology/approach - This paper uses regression techniques based on 1,557 farm household surveys gathered by the authors in Shaanxi, Gansu and Henan Provinces in 2007 and 2008. Findings - The paper argues that informal lending amongst friends and relatives cannot be dismissed as a significant economic factor in the financing of China's agricultural sector. A small farm bias in formal lending is indicated by the results, but there are many factors other than credit rationing which affect a households' decision to borrow informally. Research limitations/implications - The research is limited to the survey data used. China's agricultural economy is too large to assert that the informal‐formal relationships described herein are general, even though the results are supported by other research. Practical implications - The paper makes the case that the study of agricultural finance in China should include informal lending as part of any credit study. In addition, the paper argues that the use of the term “informal lending” should not generally group familial lending with other forms of interest‐bearing loans such as pawn shops or money lenders. Social implications - China's rural credit needs are huge and many farmers do not have access to formal credit. This paper argues that the strength of trust relationships between friends and family is sufficiently high that nearly 60 percent of all credit outstanding is between friends and relatives at zero interest rates. Originality/value - This, it is believed, is one of the first comprehensive studies on informal lending in China.