Can Small Business Lending Programs Disincentivize Growth? Evidence from India's Priority Sector Lending Program

Abstract

Programs to direct finance to small firms are ubiquitous. We study their real-side effects for target firms, exploiting the discontinuities in eligibility in such a program in India. We show that small firm lending programs can slow real growth. Several robustness, placebo, heterogeneity, and external validation tests as well as extensive margin tests are consistent with such distortionary effects. These findings collectively show that financial constraints matter: they shape how firms form and grow. Firms give up growth for better financing access but in doing so, they distort their growth trajectories by remaining small for longer periods of time.

Keywords: Small Business Lending, Soft Information, Lending Quotas, Bank Power, Small Firm Growth

JEL Classification: G31, G28, D04, O43