This paper shows that expanding bank credit in developing economies stimulates firm activity but tilts its composition toward informality. Using matched administrative records on 1.7 million Mexican firms and 127 banks over 2004–2024, we identify bank-specific credit-supply shocks within firms across banks and construct a leave-one-market-out shift-share instrument for local credit growth. A one-percent credit expansion raises the local stock of firms with an elasticity of 0.18, and the response is statistically indistinguishable across the formal and informal sectors (0.20 vs. 0.17). Entry, exit, and informal-to-formal transitions move together; informal employment responds more than formal employment; and average value added per firm falls by 0.07 percent. A dynamic model of firm entry, exit, and sector choice under sector-specific financial frictions reproduces these patterns through a single mechanism: relaxing credit constraints disproportionately admits low-productivity entrants into the informal sector, expanding aggregate activity while lowering average productivity. Financial development in emerging economies therefore confronts a fundamental trade-off, better credit access stimulates firm activity but reshapes it toward informality.