Ethnic networks and access to credit: evidence from the manufacturing sector in KenyaIntroductionDataDeterminants of access to overdrafts and supplier creditRegression modelDeterminants of access to bank overdraftsDeterminants of access to suppliers creditIs more supplier credit given within the same ethnic group?Other possible reasons for the regression resultsOmitted variablesFailure to distinguish demand from supplyInformation transmission and reputation mechanismsInitiating a credit relationshipScreening potential borrowersSocializing with suppliersConcluding observationsAcknowledgementsReferencesJournal of Economic Behavior & OrganizationVol. 49 (2002) 473–486Ethnic networks and access to credit: evidencefrom the manufacturing sector in KenyaTyler Biggsa, Mayank Raturib,∗, Pradeep SrivastavacaThe World Bank, 1818 H Street, Washington, DC USAbSwiss Re, Economic Research and Consulting, 55 East 52nd Street, New York, NY 10055, USAcNational Council of Applied Economic Research, 11 I.P. Estate, New Delhi, IndiaReceived 5 October 1999; received in revised form 10 April 2001; accepted 15 October 2001AbstractIt is often anecdotally observed that networks can facilitate exchange, but there are few empiricalstudies that explore the significance of such networks. In this paper, we analyze the impact of ethnicnetworks on access to finance of Kenyan firms using an exceptionally rich data set. We find thatethnicity does not affect access to formal sources of finance, but being a member of an ethnic groupis significant in explaining access to informal sources of finance like supplier credit. We interpret,these results in terms of information and contract enforcement mechanisms that work within ethnicgroups but not across them.© 2002 Elsevier Science B.V. All rights reserved.JEL classification: JD82; L14Keywords: Ethnic networks; Information; Enforcement; Supplier credit1. IntroductionIt is often observed that when full information and formal third party enforcement ofcontracts are not available, ethnic networks can facilitate exchange.1This is best illustratedin the words of an Indian diamond merchant from New York interviewed by Kotkin (1993).We Jains are very close and everyone knows everyone.2In a business like ours this is very important sinceyou are entrusting to people all the time to carry small packets of merchandise that could be worth hundred ofdollars.... If you break the rules, you risk being cast totally out of the group.∗Corresponding author. Tel.: +1-212-317-5673.E-mail address: [email protected] (M. Raturi).1Also see Hamilton (1994), Redding (1990) and Pyatt and Redding (1995) which discuss successful ethnicgroups.2Jains belong to Jainism, a religion practiced by about four million Indians who have historically done well inbusiness.0167-2681/02/$ – see front matter © 2002 Elsevier Science B.V. All rights reserved.PII: S0167-2681(02)00030-6474 T. Biggs et al./J. of Economic Behavior & Org. 49 (2002) 473–486Gransovetter (1994) argues that what distinguishes business groups from other businessassociations such as Chambers of Commerce, is the social element of group characteristicsamong members, which may be based on shared kinship, or ethnic or common background.In countries where ethnic groups are a minority, these informal networksare often importantingredients to the success of its members.3Although,economistshavea long tradition of analyzing “economic”bases for identifyingbusiness groups, such as equity cross ownership by members, or interlocking directorates,formal economic analysis of ethnic networks is of relatively more recent vintage. Thefocus of this analysis has been on theoretical models that emphasize the importance ofbetter information flowsand availability of informal enforcement mechanisms within ethnicgroups, both of which serve to lower transactions costs.4On the other hand, there are few studies that have rigorously analyzed empirical dataon this issue. This is because we rarely have data that allows exploring the significance ofinformation flows and enforcement mechanisms within ethnic groups. Consequently, weknow little of the precise mechanisms through which close ethnic ties might facilitate trade.In this paper, we analyze the role of ethnicity, information flows and contract enforcementin determining access to credit of firms in Kenya using exceptionally rich data on a varietyof firm transactions.5A key advantage of focussing on Kenya is the presence in the economy of two ethnicallydistinct groups of businesses, namely, those owned by entrepreneurs of Asian (largelyIndian) origin and others owned by Kenyan–Africans. While the former constitute a smallminority, their presence in trade and manufacturing is substantial (Himbara, 1994).There are a number of reasons to believe that there might be extensive informationflows amongst Kenyan–Asian entrepreneurs. For example, the formal or organized sectorin Kenya is relatively small with correspondingly few players, most of whom since Kenyanindependence have been Kenyan–Asian. In addition, for various political and historicalreasons,thisimmigrantentrepreneurialcommunityissociallyverycloselyknit,forexample,its members tend to live in clusters of close proximity, have social clubs that are vigorouslyparticipated in, and have numerous community activities both within and outside theseclubs.None the less, the question still needs to be addressed, does the structure of trade creditarrangements actually reflect such extensive information exchange among the commu-nity members? In this paper, we explore this question and show not only that ethnicityaffects credit market outcomes, but also describe the channels through which it might op-erate. In the process, we provide empirical evidence using quantitative and qualitative datasupporting extensive flows of information and reputation amongst Asian ethnic groups inKenya.3“In countries with businesspersons of ethnic minority, this ethnic status is often a source of solidarity amongbusiness groups, supplementing that of pure kinship....Whether it is [several examples of ethnic minorities cited,along with references to studies on each one], ethnicity provides an axis of differentiating along which memberscan build trust”, Gransovetter (1994, p. 463).4See Hart (1998), Greif (1994),and Milgrom et al. (1991).5Access to external financing is widely recognized as critical to business success. For a description of theimportance of informal