Political Uncertainty and the Geographic Allocation of Credit: Evidence from Small Businesses

Abstract

We investigate how political uncertainty affects the geographic distribution of bank lending to small businesses. Using exogenous variation in gubernatorial elections with binding term limits, we show that political uncertainty causes local banks to increase lending to small firms in the other states where they operate, especially in the wealthier counties. The increase in credit availability in turn leads to an increase in employment growth and net firm creation in those states, especially in sectors that need larger amounts of startup capital. Our results indicate that geographic diversification and financial integration enable banks to sidestep the negative local economic effects of political uncertainty.

Keywords: political uncertainty, banking industry, small firms

JEL Classification: G21, L26, M13