Contents lists available at ScienceDirect Regional Science and Urban Economics journal homepage: www.elsevier.com/locate/regsciurbeco Informal borrowing and home purchase: Evidence from urban China ☆ Ying Fan, Jing Wu ⁎ , Zan Yang Hang Lung Center for Real Estate, Institute of Real Estate, Tsinghua University, China ARTICLE INFO JEL codes: D14 G21 E26 Keywords: Informal borrowing Social capital Housing demand China ABSTRACT In this paper, we provide a new explanation for the co-existence of huge housing demand and low dependence on mortgage loans in urban China, focusing on the effect of households’ informal borrowing from relatives and friends. Empirical analysis based on a national-level household survey suggests that because of the low financial cost of informal borrowing, households tend to borrow as much as possible from informal channels until they reach the constraint determined by their social capital, which significantly crowds out formal borrowing such as mortgage loans from commercial banks. Additionally, the existence of informal borrowing significantly increases households’ housing demand. Understanding these effects is especially important in regions with less mature financial systems. 1. Introduction The demand for urban housing in China has increased rapidly since the housing reform in the late 1990s (Wang, 2011), and China has become the largest housing market globally. According to the National Bureau of Statistics of China (NBSC), urban households spent 43.4 trillion RMB on housing purchases between 2000 and 2014 and over 7 trillion RMB in 2014 alone. The living space per capita in urban China has increased continuously from about 20 sq. m. in 2000 to over 34 sq. m. in 2014. Housing has also become the largest asset in urban households’ balance sheets (Li and Wu, 2014). This huge housing demand in China has attracted global research interest, and two facts are highlighted in the literature. The first is the large expenditure on housing purchases compared with buyers’ current incomes (Yang and Shen, 2008; Yang and Chen, 2014). Wu et al. (2012, 2015) find the average price-to-income ratio in 35 major Chinese cities to be much higher than in most developed economies such as the U.S. Fang et al. (2015) find the average price-to-income ratio to be over 10 in first-tier cities and emphasize that even households in the bottom- income cohort are actively involved in purchasing residential units under huge financial burdens. As a conventional method of formal borrowing, mortgage loans are widely regarded as an important financing channel in households’ housing purchases (Leece, 2008). However, Chinese households are well known for their low dependence on mortgage loans from commercial banks (Deng and Fei, 2008). According to the statistics from the Urban Household Survey conducted by NBSC, only 17% of homebuyers in urban China received mortgage loans between 2002 and 2009. In 2012, the outstanding balance of residential mortgages made up only 14.5% of GDP in China, which was much lower than in Japan (39%), the U.S. (72%), and the U.K. (86%). 1 These two facts jointly suggest that China's urban households must depend on other channels to finance their home purchases. Whereas most studies connect these facts to the high saving rate in China (Chamon and Prasad, 2010), in this paper, we focus on another informal financial arrangement: borrowing from relatives and friends based on social capital. Our empirical results, based on the Chinese Household Finance Survey (CHFS), indicate that such informal bor- rowing in China plays an important role in households’ home pur- chases. Two findings are particularly noteworthy. First, because of the lower cost of informal borrowing, households tend to borrow from informal channels as much as possible until they reach the constraint given by their social capital; thus, informal borrowing crowds out formal borrowing such as mortgage loans from commercial banks. Second, informal borrowing can significantly boost home purchasers’ housing demand; in other words, households who have better social capital and thus access to more informal borrowing tend to spend significantly more on home purchases and to buy larger and better http://dx.doi.org/10.1016/j.regsciurbeco.2017.09.003 Received 3 October 2016; Received in revised form 30 May 2017; Accepted 11 September 2017 ☆ We are grateful for the comments of the editor and two anonymous referees. This research is supported by the National Natural Science Foundation of China (Nos. 71673154, 71073090, 71461137002, 71373006, and 91546113) and Tsinghua University Initiative Scientific Research Program (20151080431). The usual disclaimer applies. ⁎ Corresponding author. E-mail address: ireswujing@tsinghua.edu.cn (J. Wu). 1 Data source: Global Financial Stability Report Durable Financial Stability: Getting There from Here, 2013. Regional Science and Urban Economics 67 (2017) 108–118 Available online 14 September 2017 0166-0462/ © 2017 Elsevier B.V. All rights reserved. MARK