Banking Structure and Dynamics of Small and Medium Sized Enterprises

This project was part of the team project "The Dynamics of Finance, Competition and Information Production ".

Topics & Objectives

We analyze the effect of banking structure and competition on the dynamics of the growth and financing paths of young firms. We investigate the effect of the (local) banking structure on firm and industry development. We analyze the consequences of different degrees of bank competition at the local level for the dynamics of small and medium enterprises’(SMEs) finance, investment, and innovation. In particular, we look into the impact of banking competition on firm's lifetime financing, their growth patterns as well as their innovative activities. We are thereby interested in the development paths of SMEs in general, but of young, most notably newly founded firms in high-tech industries. We ask to which extent the access to local financing opportunities and different degrees of competition, e.g., lower or higher refinancing rates, can explain different paths. We thereby try to combine the literature on access to finance for small and medium sized firms with the literature on different lending channels, specifically the role of banks, and determinants of the SMEs’ capital structures. Furthermore, we explore the implications of banking structure and bank lending on the behavior of small and medium firms in particular with regard to the innovative activities.

Key Findings

• Newly founded firms make use of formal bank lending right after their incorporation to a significant degree.

• Financially constrained newly founded firms use less external debt and invest less than their counterparts.

• Financially constrained young firms suffered relatively less in the financial crisis than their non-financially constrained firms.
• There is a causal relationship between bank lending and firms’ innovative pattern in a quasi-natural experiment.
• Regulation-induced reduction in bank lending harm the quantity of innovation but not the quality: the average quality of patents even increases