No. 223

November 2002

SMALL BUSINESS

RESEARCH

SUMMARY

The Real Effects of Liquidity on Behavior:

Evidence from Regulation and Deregulation of Credit Markets

by Jonathan Zinman, 2002 [43 pages]

under contract no. SBAHQ-01-M-0152

Massachusetts Institute of Technology

This Small Business Research Summary (ISSN 1076-8904) summarizes one of a series of research papers prepared under contracts

issued by the U.S. Small Business Administration’s Office of Advocacy. The opinions and recommendations of the authors of this study do

not necessarily reflect official policies of the SBA or other agencies of the U.S. government. For more information, write to the Office of

Advocacy at 409 Third Street S.W., Washington, DC 20416, or visit the office’s Internet site at www.sba.gov/advo.

The Office of Advocacy funded the author’s research,

which has been included as Chapters 1 and 2 of a

dissertation submitted to the department of economics of the Massachusetts Institute of Technology in

partial fulfillment of the requirements for the degree

of doctor of philosophy in economics.

Purpose

The first two chapters of this dissertation examine

the impact of the 1976 Community Reinvestment

Act (CRA) on small business lending, and especially

the 1995 reforms of this law. The CRA provides

banks with incentives for lending to small businesses

in low- and moderate-income neighborhoods since a

bank’s CRA record is considered when the bank

applies for permission to expand. As such, it is

important to determine if the CRA has significantly

affected small business lending in these areas and

whether such lending has real effects on the economy.

Overall Findings

The author presents evidence that banks with binding

CRA incentives appeared to increase their small

business lending by approximately 12 to 15 percent,

and the number of firms holding debt increased by

some 15 percent in counties with affected banks.

There is also evidence that these changes in the

availability of credit produce real changes in the

form of payroll increases and bankruptcy decreases

in the affected counties. The findings, therefore,

appear consistent with a model in which targeted

credit market interventions can improve efficiency,

although important questions remain.

Highlights

Effects of CRA on Bank Lending

• Banks affected most by the CRA reforms did

increase their small business lending, on the order of

12 to 15 percent. Moreover, CRA lending does not

appear to be completely offset by decreases in nonCRA lending, either within or across banks, indicating no clear evidence of any crowding out. For the

economy as a whole, CRA increased access to credit

for approximately 5 percent of firms overall.

Effects of CRA on Debt Holding by Potential

Borrowers

• Using Internal Revenue Service data that capture

the financial structure of potential CRA borrowers,

the study found that the probability of holding debt

increases by approximately 7 percentage points

because of CRA among affected firms relative to

unaffected firms.

• Taken together, results from tests on potential

borrowers suggest that CRA increases the number of

firms that hold debt by 7 to 10 percentage points.

Because about 60 percent of all firms are in counties
where CRA regulations are relevant, CRA increases

the total number of firms holding debt by an estimated 4 to 6 percentage points. However, the results

provide no support for the hypothesis that CRA

reforms successfully target firms in low- to middleincome areas.

Real Effects on County Payroll and on

Bankruptcies

• The point estimate suggests that CRA increases

payroll by nearly 1 percent in affected counties, although this increase is not statistically significant.

Personal (nonbusiness) bankruptcies dropped by 3.6

percent. This could be driven by the improved ability

of closely held businesses to stick it out, the

improved ability of households to smooth adverse

shocks because of increased access to credit, or some

combination of both.

Scope and Methodology

By emphasizing lending performance in the targeted

low- to moderate-income areas, the 1995 CRA

reforms make it possible to investigate the impact of

CRA regulations on small business lending by banks,

specifically by large banks and banks that are most

affected by CRA performance review. With variations in the applicability of the review reforms, several variables can be created for testing the hypotheses. Moreover, there are also substantial differences

in the propensities to regulate by the agencies

charged with enforcing CRA. Variation in “regulator

toughness” also becomes an important variable in

evaluating the impact.

An assessment of the impacts of these variables

on potential borrowers and bank lending is presented

in Chapter 1 and the effects of increased lending on

real activities in Chapter 2. The author formulated

models and estimated the statistical significance of

the critical variables as well as the magnitude of the

impacts for each variable. Data sources used include

corporate tax returns from the Internal Revenue

Service, small business lending information from the

June issues of the Federal Reserve’s call reports, bankruptcy data from the Administrative Office of the

U.S. Courts, and county payroll data from County

Business Patterns of the U.S. Bureau of Census.

Ordering Information

The full text of this report and summaries of other

studies performed under contract to the U.S. Small

Business Administration’s Office of Advocacy are

available on the Internet at www.sba.gov/advo/research.

Printed copies are available for purchase from:

National Technical Information Service

5285 Port Royal Road

Springfield, VA 22161

Tel. (800) 553-6847

TDD: (703) 487-4639

www.ntis.gov

Order number: PB2003-101101

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