The Role of Regulation and Bank Competition in Small Firm Financing: Evidence from the Community Reinvestment Act

Abstract

This paper analyzes how bank regulation that promotes greater access to credit impacts the financing of targeted small firms. It develops a model where banks compete with trade creditors to fund the operations of small firms and applies it to study the effects of the Community Reinvestment Act (CRA). The empirical tests reveal that, on average, a CRA-induced increase in bank loans reduces small firms’ use of relatively expensive trade credit. The effect is more profound in low- and medium-income areas where financial constraints are tighter due to low bank competition. The effect is also larger for small firms that operate in trade credit-dependent industries.