Working Papers

2007-07 | January 2007

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Market Power and Relationships in Small Business Lending

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The empirical research literature regarding the effects of market structure on small business lending has yielded ambiguous results. This paper empirically tests for the presence of countervailing effects of increases in market concentration on small business loan volume. Countervailing effects would be expected if both the traditional Structure, Conduct, Performance (SCP) paradigm of industrial organization and a paradigm whereby market power benefits the formation of lending relationships (the relationship hypothesis), are at work. Using Community Reinvestment Act (CRA) data on small loans to small businesses, it is found that, on average, across MSAs, SCP effects dominate. But, as predicted by the relationship hypothesis, the negative effects of increases in concentration on small business loan volume are weaker, the greater the presence of young firms and the higher the business failure rate. Relationship effects due to business failure appear to come from highly concentrated MSAs. Endogeneity concerns are further addressed with the estimation of a regression that separates out the effects of changes in the number of lenders from the effects of changes in the sum of squared deviations of market shares.

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