Market Power in Small Business Lending: A Two Dimensional Bunching Approach*

While bank lending is an important financing channel for small firms, banks in the U.S. have substantial market power. What are the efficiency implications and policy remedies to bank concentration? We build a model of bank competition with endogenous interest rates, loan size, and take-up. We estimate the model using the universe of loans made through the Small Business Administration (SBA). Our novel identification strategy builds on and extends the “bunching” literature that uses kinks and notches to identify key elasticities, utilizing a discontinuity in SBA’s interest rate cap. We find banks capture at least 30% of the surplus in a majority of lending markets. Imposing a uniform interest rate cap of 5% would increase borrower welfare by 9%, but also cause substantial rationing. While the guarantee subsidy program used by the SBA raises borrower surplus by 17%, we find that banks capture the majority of increase in surplus. *We thank Vivek Bhattacharya, Olivier Darmouni, Yiming Ma, David Sraer, Adam Szeidl, Kairong Xiao, Constantine Yannelis, Anthony Zhang, and seminar and conference participants at UNC, Princeton, and Columbia for helpful comments and discussions. We are grateful to Brian Headd at the SBA for helpful discussions and comments about institutional details. Christian Kontz and Daniel Morrison provided excellent research assistance. This draft is preliminary, please do not cite or circulate without the permission of the authors. Comments are welcome. †Princeton University. Email: nbachas@princeton.edu. ‡Princeton University. Email: ernestliu@princeton.edu.