Unintended side effects: stress tests, entrepreneurship, and innovation

Sebastian Doerr

No 823, BIS Working Papers from Bank for International Settlements

Abstract: Post-crisis stress tests have helped to enhance financial stability and to reduce banks' risk-taking. In order to quantify their overall impact, regulators have turned to evaluating the effects of stress tests on financing and the real economy. Using the U.S. as a laboratory, this paper shows that stress tests have had potentially unintended side effects on entrepreneurship and innovation at young firms. Banks subject to stress tests have strongly cut small business loans secured by home equity, an important source of financing for entrepreneurs. Lower credit supply has led to a relative decline in entrepreneurship during the recovery in counties with higher exposure to stress tested banks. The decline has been steeper in sectors with a higher share of young firms using home equity financing, i.e. where the reduction in credit hit hardest. Counties with higher exposure have also seen a decline in patent applications by young firms. I provide suggestive evidence that the decline in credit has negatively affected labor productivity, reflecting young firms' disproportionate contribution to growth. My results do not imply that stress tests reduce welfare, but highlight a possible trade-off between financial stability and economic dynamism. The effects of stress tests on entrepreneurship should be taken into account when evaluating their effectiveness.

Keywords: stress tests; small business lending; entrepreneurship; innovation; productivity slowdown (search for similar items in EconPapers)
JEL-codes: G20 G21 L26 (search for similar items in EconPapers)
Pages: 55 pages
Date: 2019-11
New Economics Papers: this item is included in nep-ban, nep-ent, nep-fdg, nep-ino and nep-sbm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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