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A closer bank-firm relationship is beneficial to corporate development since firms are able to mitigate their financing constraints through direct or indirect means, such as related-party loans or signalling. This results in more firms tending to invest in financial institutions. This paper matches 615 firms investing in nonlisted financial institutions over the period 2007 to 2011 with 615 firms of the closest asset size in the same industry and year but without such investment. We find that investing in financial institutions can be beneficial for firms. It can lower the financing constraints and demand for cash reserves, not only directly (due to the close relationship between holding firms and financial institutions), but also indirectly (due to the influence on financing constraints, which require a higher level of cash holdings). Higher financing constraints will stimulate firms to hold more cash, while investing in financial institutions can enable such firms to reduce their reserves. When we divide the shareholdings further into nonlisted banks and nonlisted, nonbanking institutions, we find that the former does not significantly affect financing constraints and cash holdings, but the latter effectively alleviates firms’ financing constraints and reduces the level of cash. Furthermore, we find that the influence of investing in financial institutions is more evident for NSOEs than SOEs in China.

Shareholdings in Financial Institutions, Financing Constraints, and Cash Reserves1