Unintended Side Effects: Stress Tests, Entrepreneurship, and Innovation

Abstract

This paper shows that post-crisis stress tests have negative effects on entrepreneurship and innovation at young firms. Exploiting unique data on business-related home equity loans in HMDA, I show that stress tested banks strongly cut small business loans secured by home equity, an important source of financing for entrepreneurs. Lower credit supply leads to a relative decline in entrepreneurship in counties with higher exposure to stress tested banks. The decline is stronger in sectors with a higher share of young firms using home equity financing, i.e., in which the reduction in credit hits hardest. More-exposed counties also see a decline in young firms’ patent applications as well as labor productivity, reflecting young firms’ disproportionate contribution to growth.