The role of formal and informal finance in the informal sector in Ghana

Within the developing world, especially Sub-Saharan Africa (SSA), informal (small and medium) enterprises’ (SMEs) access to financing has been extremely limited mainly because of the reluctance of banks and other formal financial institutions to lend to such firms. The impact of this challenge on their growth trajectory has remained relatively indeterminate. This study examines the differential impact of sources of finance on the growth of informal firms in Ghana. We employ the Heckman Selection Technique (HST) to model the selection process of firm financing choices and reverse causality problem. By making use of the World Bank’s enterprise survey data on 720 informal firms in Ghana from 2007 – 2010, we find that formal sources of finance, compared to informal sources, are superior in their impact on firms in Ghana. Formal finance institutions, with their ability to provide more than just finance, positively affect firm growth. This result has an important policy implication for the current focus of Government of Ghana in promoting indigenous entrepreneurship through initiatives that will enhance access to financial support of local enterprises in Ghana. In view of this, this study proposes that Government policy towards formal financing institutions and their lending to informal sector need adjustments to provide incentives that will encourage increased lending to informal firms.