Credit and Income Inequality

How does credit access for small business owners affect income inequality? A bank’s cutoff rule, employed in the decision to grant loans and based on applicants’ credit scores, provides us with the exogenous variation needed to answer this question. Analyzing uniquely detailed loan application data, we find that application acceptance increases recipients’ income five years later by more than 10 percent compared to denied applicants. This effect is mostly driven by upward mobility of poor individuals, especially if credit-constrained, thereby reducing income inequality among those who get credit. Looking across various salient groups of applicants, we find that relatively constrained groups—that is, firms from low-income regions, new or high-growth firms, or female-owned firms—display higher responses to credit origination for their relatively poor applicants, while the effects for the rich applicants are at best negligible.