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

Abstract

We investigate how banks change the geographic distribution of their small business loan portfolio when they face political uncertainty in some of the states where they operate. Using exogenous variation in gubernatorial elections with binding term limits, we show that political uncertainty causes local banks to increase out-of-state lending to small firms, especially to firms located in the wealthiest out-of-state counties. The increase in credit availability in turn leads to an increase in employment growth and net firm creation 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