Does Banking Competition Really Increase Credit for All? The Effect of Bank Branching Deregulation on Small Business Credit

In this paper, I quantify the extent to which financial constraints limit the scope of activity of small firms, influence their labor decisions, and impact their ultimate survival. Using the U.S. branching deregulation from the 1990s, I document that local markets within deregulated states experienced an increase in their number of branches, driven by the entry of larger out-of-state banks and a decrease in the number of branches of existing local banks. As a result, small businesses were affected disproportionally. On average, in the treated markets, the overall lending to small businesses initially declined by 5.4% and remained lower for several years. The decline in credit supply eventually led to a decrease in the number of small businesses; however, many firms were able to stay in operation by decreasing their demand for labor. Specifically, there was an immediate decline in the employment and hours worked at small firms in newly deregulated markets, and even as small business lending recovered, these levels remained depressed for many years after that. Overall, the results demonstrate the critical dependence of small businesses on relationship lending by local banks and show how temporary negative credit supply shocks can have persistent adverse effects on labor