Supervisory Ratings and Bank Lending to Small Businesses During the Financial Crisis and Great Recession

Bank lending to small firms in the U.S. fell substantially during the recent financial crisis and ensuing recession. Because small firms account for a disproportionate share of new job creation, lending to these firms could have important implications for the pace of economic recovery. This paper examines the extent to which changes in banks' supervisory ratings are associated with changes in the growth rate of their lending to small businesses. We estimate the relationship between changes in small banks' supervisory ratings and changes in their small commercial and industrial (C&I) or small commercial real estate (CRE) loans to businesses over 2007-2010. Controlling for a large set of other relevant factors, we find that small banks that experienced ratings downgrades during 2007-2010 exhibited significantly lower rates of growth in small C&I loans and small CRE loans outstanding compared with banks that maintained their ratings at healthy levels during the same period. We employ an innovative approach using the timing of bank exams to address the question of whether the slower growth in small business lending at downgraded banks is attributable mainly to aspects of the banks' financial health that are not fully reflected in balance sheet data or to the ratings downgrades themselves. Our results suggest that the downgrades themselves did not directly influence bank lending to small businesses during this period.