Defunding Controversial Industries: Can Targeted Credit Rationing Choke Firms?

Abstract

This paper examines the effects of targeted credit rationing by banks on firms likely to generate negative externalities. We exploit an initiative of the U.S. Department of Justice, labeled Operation Choke Point, which compelled banks to limit relationships with firms in industries prone to fraud and money laundering. Using supervisory loan-level data, we find that, as intended, targeted banks reduce lending and terminate relationships with affected firms. However, most firms fully substitute credit through non-targeted banks under similar terms. Overall, the performance and investment of these firms remain unchanged, suggesting that targeted credit rationing is widely ineffective in promoting change.

Keywords: bank-firm relationships, credit rationing, social-oriented banking

JEL Classification: G21, G28, G30, G32, G38