Choice between formal and informal financing in cottage industry firm: The application of robust regression

• Published date: 01 February 2022
• Author: Salman Wahab,Adnan Safi,Zeeshan Wahab,Nawaz Ali Shah,Xibao Zhang
• Date: 01 February 2022
• DOI: http://doi.org/10.1002/pa.2241

ACADEMIC PAPER

Choice between formal and informal financing in cottage

industry firm: The application of robust regression

Salman Wahab

1

| Adnan Safi

1

| Zeeshan Wahab

2

| Nawaz Ali Shah

1

|

Xibao Zhang

1

1

School of Economics, Qingdao University,

Qingdao University, Qingdao, Shandong, China

2

School of Economics, Government Post

Graduate Jahanzeb College, Saidu Sharif Swat,

Pakistan

Correspondence

Xibao Zhang, School of Economics, Qingdao

University, Qingdao, Shandong 266000, China.

Email: xibao.zhang@qdu.edu.cn

This article aims to analyze the effect of formal and informal financing on the growth

of cottage industry firms in village Islampur in Swat one of the districts of Khyber

Pakhtunkhwa Pakistan. Primary data were collected through Focused Group Discus-

sions (FGD) and a total of 208 cottage industry firms were surveyed. Robust Regres-

sion techniques were employed to analyze the data. The results show that informal

financing has a higher impact than formal financing on the growth of the small firms

in the study area. There is a tendency for informal borrowing among the small size

firms' owners due to the fact that access to formal sources is hindered by a multitude

of factors including high interest rate, complex application procedure, and demand

for a collateral among others. On the contrary, we find that in case of large size firms,

formal financing has a significant influence on firms' growth for cottage industry.

Moreover, in co-financing where the ratio of informal is greater than formal financing

has a significant positive effect on the firm's growth. The findings of the study have

implications for devising loan policies of the financial institutions to take into account

these factors. The financial institutions need to come up with packages that meets

the need of the small and medium enterprises.

1|INTRODUCTION

There is vital role of the small and medium enterprises (SMEs) in the

economic growth of a country. Nonetheless, there various factors

which affect the performance of the SMEs. There are several factors

including both financial and nonfinancial which affect the growth of

SMEs. Such factors mainly include the sources of financing, including

internal, external, formal or informal sources, size of the firm, lack of

skills and technical knowledge, the age of the firm, political situations

in the country, lack of access to new markets, poor management, high

cost of borrowing, judicial system, ownership of the firm, and govern-

ment policies which affect the growth of SMEs (Saito &Villanueva,

1981; Peel & Wilson, 1996; Liedholm et al., 1994).

cer factors, source of financing has important bea rings on firms'

growth. Firms that could not get high growth rate are affected by fac-

tors other than nonfinancial factors (Liedholm et al., 199 4). There is

ample evidence that firms with bank financing gro w faster than firms

without bank financing (Ayyagari, Kunt, & Miksimovi c, 2010). Firms'

growth is also affected by factors such as ineffi cient management,

lack of skills particularly technical skills, less focus on market

research, and lacking of planning (Murphy et al., 1996; Van-St el &

Storey, 2004).

The role of financing among all of the above-mentioned factors

has been viewed as one of the critical element for the growth of

SMEs. Financing of the firm are considered as a key factor for the

growth of SMEs. Further, according to the World Bank report (2016)

50% of the total SME's in the world are confronted with the problem

of lacking finances. Although, there has been an extensive research on

the role of financing on firm growth, nonetheless, there is little evi-

dence on the role of financing on the growth of cottage industry in

the province of Khyber Pakhtunkhwa and especially in the war hit

areas of District Swat. The valley of Swat has suffered huge losses

due to the war on militancy and like other sectors; the cottage indus-

try in the village Islampur has suffered huge losses due to the closer

of the units and displacement of the local owner during the war. Tak-

ing into account this research was carried out to assess the role of

Received: 12 May 2020 Revised: 31 May 2020 Accepted: 18 June 2020

DOI: 10.1002/pa.2241

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https://doi.org/10.1002/pa.2241