Bank Lending and Corporate Innovation: Evidence from SFAS 166/167*

Understanding the role of bank lending in corporate innovation is important to policymakers, practitioners, and academics. We provide new evidence on such a role by exploiting the implementation of SFAS 166/167, which removed the off-balance sheet status of certain securitized assets of banks. The regulation affects bank lending and thus represents a credit supply shock to borrowing firms. We find that affected banks raise spreads and cut loan amounts after the regulation. Firms that borrow from affected banks reduce R&D investment and the number and quality of the patents they generate. The reduction is concentrated among firms whose banks experience more downward pressure on capital ratios and greater market discipline, and firms that are more dependent on external financing. Additional analyses reveal that information asymmetry between incumbent banks and outsiders with respect to borrowing firms prevent them from switching. The overall findings suggest that bank lending promotes borrowing firms' innovation activities. Policies that restrict bank lending are likely to hurt innovation of borrowers.