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Formal and Informal Finance: Mechanisms, Efficiency and Empirical Challenges
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TitleFormal and Informal Finance: Mechanisms, Efficiency and Empirical Challenges  
AuthorGao Ming and Liu Yuzhen  
OrganizationGuanghua School of Management, Peking University; 
Key WordsFormal Finance; Informal Finance; Mechanisms; Efficiency; Economic Development 
AbstractThe relationship between formal and informal finance is not only a fundamental academic issue, but also a theoretical framework for the China's financial system reform. This paper discusses the relative efficiency and its determinants of formal and informal finance by establishing theoretical framework from mechanisms’ perspective, and further points out the contributions and challenges of the existing empirical literatures by analyzing the definitions, classifications, sampling and research methods. The paper then discusses how to improve the efficiency of the formal and informal finance by considering Chinese unique features, and provides suggestions on upgrading the indirect financial system in China. The paper concludes with suggestions for future researches. This paper proposes that formal and informal finance have their own unique advantages due to the difference in information and enforcement mechanisms, and their relative efficiency depends on the stage of economic and financial development. The existing empirical results have been controversial mainly due to the classifications, limitations of samples and endogenous problem. Regarding China issues, this paper advocates to deregulate our financial systems, abandon the urban-rural dual system, enhance the financial access and efficiency of the formal finance, and promote self-regulation and efficiency of informal finance. An efficient indirect financial system should be built through free competition of informal and informal finance. 
Serial NumberWP591 
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