Impact of Bank Closings on Credit Extension to Businesses in Low-Income and Minority Neighborhoods

Abstract

New research is surfacing since the last financial crisis, not only to help predict risks associated with bank failures but also to assess the impact of bank failures on the economy and local geographies. However, although bank failures occurred mostly among small (community) banks, much less is understood regarding how the closing of mission-oriented community banks, or minority-owned banks, affect traditionally underserved markets, areas such failed banks were designed to serve. We conduct an empirical investigation testing the effects of bank closings on local areas. We find that, as a result of bank closings, there are significant frictions with small businesses obtaining credit, which appear to be potent enough to cause cumulative declines in aggregate small business lending in neighborhoods, lasting up to 3 years. We also find evidence that such lending shocks have repercussions on small business growth. We find that the closing of large banks also has an impact on small business lending, consistent with previous research, which has shown that as small businesses lose credit from large banks, they are not able to switch easily to other banks, leading to a decline in aggregate lending in local areas. We find this to be true for low- or moderate-income (LMI) and minority businesses/neighborhoods. We also find that the failure of community development financial institutions (CDFIs) and minority depository institutions (MDIs) leaves a credit void that may not automatically be filled in LMI and minority neighborhoods.