The Importance of Financial Market Development on the Relationship between Loan Guarantees for SMEs and Local Market Employment Rates

Working papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded offi cial Federal Reserve Bank of Cleveland publications. The views stated herein are those of the authors and are not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. We empirically examine whether a major government intervention in the small-fi rm credit market yields signifi cantly better results in markets that are less fi nancially developed. The government intervention that we investigate is SBA-guaranteed lending. The literature on fi nancing small and medium size enterprises (SMEs) suggests that small fi rms may be exposed to a particular type of market failure associated with credit rationing. And SMEs in markets that are less fi nancially developed will likely face a greater degree of this market failure. To test our hypothesis, we use the level of bank deposits per capita as our relative measure of fi nancial market development, and we use local market employment rates as our measure of economic performance. After controlling for the appropriate cross-sectional market characteristics, we fi nd that SBA-guaranteed lending has a signifi cantly more (less) positive impact on the average annual level of employment when the local market is relatively less (more) fi nancially developed. This result has important implications for public policy directives concerning where SBA-guaranteed lending should be directed.