Regulatory Risk Perception and Small Business Lending

We uncover a significant friction in small business lending: perception of risk by Small Business Administration (SBA) employees. Using novel data on SBA employees transferring across offices, we find that more current defaults on SBA loans in their previous location reduce SBA loans and job creation in their current location. The effect is independent of local economic conditions and the informational content of the nonlocal defaults, suggesting that SBA employees update their risk assessment irrationally. Our results are the first to document that regulators’ misperception of economic conditions affects the ability of small businesses to obtain access to finance. This paper was accepted by Camelia Kuhnen, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2023.03040 .