Unintended Side Effects: Stress Tests, Entrepreneurship, and Innovation

55 Pages Posted: 13 Dec 2019

See all articles by Sebastian Doerr

Sebastian Doerr

Bank for International Settlements

Multiple version iconThere are 2 versions of this paper

Date Written: November 22, 2019

Abstract

Post-crisis stress tests have helped to enhance financial stability and to reduce banks' risk-taking. In order to quantify their overall impact, regulators have turned to evaluating the effects of stress tests on financing and the real economy. Using the U.S. as a laboratory, this paper shows that stress tests have had potentially unintended side effects on entrepreneurship and innovation at young firms. Banks subject to stress tests have strongly cut small business loans secured by home equity, an important source of financing for entrepreneurs. Lower credit supply has led to a relative decline in entrepreneurship during the recovery in counties with higher exposure to stress tested banks. The decline has been steeper in sectors with a higher share of young firms using home equity financing, i.e. where the reduction in credit hit hardest. Counties with higher exposure have also seen a decline in patent applications by young firms. I provide suggestive evidence that the decline in credit has negatively affected labor productivity, reflecting young firms' disproportionate contribution to growth. My results do not imply that stress tests reduce welfare, but highlight a possible trade-off between financial stability and economic dynamism. The effects of stress tests on entrepreneurship should be taken into account when evaluating their effectiveness.

Keywords: stress tests, small business lending, entrepreneurship, innovation, productivity slowdown

JEL Classification: G20, G21, L26

Suggested Citation

Doerr, Sebastian, Unintended Side Effects: Stress Tests, Entrepreneurship, and Innovation (November 22, 2019). BIS Working Paper No. 823, Available at SSRN: https://ssrn.com/abstract=3502456

Sebastian Doerr (Contact Author)

Bank for International Settlements ( email )

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