This study aims to investigate the role of trade credit in improving access to formal credit for informal firms in Africa, where informal enterprises dominate employment and significantly contribute to economic activity. Despite their economic importance, these firms face considerable challenges in accessing formal financial systems, necessitating alternative mechanisms like trade credit.
The study utilizes cross-sectional data from the World Bank Informal Enterprise Survey for eight African countries. A recursive bivariate probit model is employed to estimate the effects of inward (supplier-provided) and outward (customer-extended) trade credit on the likelihood of accessing formal credit.
The results reveal that inward trade credit and the joint use of inward and outward trade credit significantly improve the probability of accessing formal credit. Using only outward trade credit didn’t significantly influence formal credit access. Firms engaging in inward trade credit benefit from signalling financial reliability and operational stability to formal lenders. Additionally, the study highlights the importance of formal business practices, such as recordkeeping and maintaining a bank account, in facilitating access to formal credit.
The findings suggest that formalizing trade credit practices and encouraging recordkeeping can enhance informal firms’ access to formal credit.
This research contributes to the literature on informal enterprise financing by emphasizing the critical role of trade credit as both a substitute for and complement to formal credit. The study provides actionable insights for policymakers and financial institutions, highlighting the importance of formalizing trade credit practices, developing targeted financial products, to enhance financial inclusion in Africa.
