suffering from competition of informal firms have a significantly lower probability of accessing credit, as proxied by loan availability. This result goes over and beyond standard measures for firms’ creditworthiness and informational opacity such as age or size. We also document that exposure to competition from informal firms significantly reduces loan application. These results are robust to several checks of the estimation strategy, including sample selection, and the use of an IV strategy and matching technique. Finally, we explore a possible mechanism explaining this result. We provide suggestive evidence that the negative effect of competition from informal firms on formal firms’ loan applications operates through a reduction in the firm’s expected future sales. To this end, we show that expectations on future sales growth are significantly lower for firms reporting to be more exposed to competition from informal firms. Importantly, this effect is unrelated to differential realized sales in the past, a proxy for growth opportunities. Then, we show that expectations on future sales growth predict loan applications, which is positively correlated with employment growth.

Our paper is related and contributes to three strands of literature. First, our paper relates to the vast literature on the effect of the informal sector on the economy (Perry et al., 2007; Maloney, 2004; La Porta and Shleifer, 2014). Informality is a distinguishing characteristic of most developing economies and it is widely shown to impact the behavior and performance of firms operating in the formal sector. Ulyssea (2018) show that the coexistence and competition of informal firms with more productive (formal) companies lead to a misallocation of resources and potentially large losses in total factor productivity. Moreover, a number of studies have documented that informal competition has a negative effect on formal firms in terms of output (Rozo and Winkler, 2021), employment (Amin, 2021), productivity (Amin and Okou, 2020), quality of products (Banerji and Jain, 2007), and innovation (Avenyo et al., 2021). Lastly, Distinguin et al. (2016) provide evidence that the presence of informal competition makes formal SMEs’ more likely to be creditconstrained. Our analysis contributes to this literature by showing that the impact of informality on the formal sector depends on the _perceived_ threat that formal firms associate to informal competition. This, in turn, has relevant effects on firms’ expectations, investment decisions, and borrowing choices. As such, our paper provides an important piece of the puzzle in the understanding of the effect of informality on the functioning of the formal economy.

Second, our paper speaks to the literature on the determinants of firms’ access to finance in developing countries. Several studies have analyzed how availability of finance is linked to firms’ characteristics (Beck et al., 2005, 2008) and emphasized the existence of obstacles to the supply of credit (Banerjee and Duflo, 2014; Kersten et al., 2017). Bigsten et al. (2003) use data from African countries to document how inefficiencies in the credit market lead micro-sized and small firms to a lower probability of loan access compared to larger companies. Kuntchev et al. (2014) make use of WBES data to show that credit availability is inversely 2