Legacy Lending Relationships and Credit Rationing: Evidence from the Paycheck Protection Program
Abstract
This article examines how legacy lending relationships shape the allocation of emergency credit under severe information frictions. Using a novel dataset linking Small Business Administration (SBA) loan records with Dun and Bradstreet microdata for over 26 million U.S. firms, I investigate whether prior participation in the SBA 7(a) program acted as a gateway to the Paycheck Protection Program (PPP). Employing entropy balancing to construct a strictly comparable counterfactual group, I document a distinct dynamic evolution in credit rationing. In the program's initial "panic phase" in April 2020, banks relied heavily on legacy ties as a screening technology: firms with prior 7(a) relationships were approximately 29 percentage points more likely to receive funding than observationally identical non-7(a) firms. By June 2021, however, this insider advantage had largely vanished, suggesting that policy adjustments and extended timelines eventually mitigated the initial intermediation frictions. These findings highlight a fundamental trade-off between speed and equity in crisis response. While leveraging existing credit rails accelerates deployment, it systematically excludes informationally opaque borrowers. I discuss policy implications for designing future digital infrastructure to decouple verification from historical lending relationships.
Summary
This paper investigates how pre-existing lending relationships, specifically prior participation in the SBA 7(a) program, influenced access to the Paycheck Protection Program (PPP) during the COVID-19 pandemic. The research leverages a novel dataset linking SBA loan records with Dun & Bradstreet microdata for over 26 million U.S. firms. The author employs entropy balancing, a rigorous reweighting method, to construct a comparable counterfactual group and estimate the causal effect of prior 7(a) participation. The key finding is that in the initial "panic phase" of the PPP (April 2020), firms with prior 7(a) relationships were significantly more likely (approximately 29 percentage points) to receive funding than observationally identical non-7(a) firms. This suggests that banks relied heavily on legacy ties as a screening mechanism due to severe information frictions. However, this "insider advantage" diminished considerably by June 2021, indicating that policy adjustments and extended timelines helped mitigate the initial intermediation barriers. The study highlights a trade-off between speed and equity in crisis response, where leveraging existing credit rails accelerates deployment but systematically excludes informationally opaque borrowers. The paper contributes to the small business finance and crisis management literature by quantifying the "program-layering premium," showing that participation in programs like 7(a) provides an advantage in accessing future emergency aid. It also offers a dynamic assessment of the speed-equity trade-off, demonstrating that initial allocation inequalities were partially corrected over time. The research concludes by suggesting that future emergency lending infrastructures should move beyond reliance on legacy banking relationships and adopt more inclusive, pre-qualified digital verification systems.
Key Insights
- •Firms with prior 7(a) relationships were approximately 29 percentage points more likely to receive PPP funding in April 2020 compared to observationally similar firms without such relationships.
- •The "insider advantage" conferred by prior 7(a) participation largely vanished by June 2021, suggesting a learning curve in crisis response and the mitigation of initial information frictions.
- •The study quantifies the "program-layering premium," demonstrating that participation in peacetime guarantee programs creates an embedded advantage for accessing future emergency aid.
- •Entropy balancing was used to create a synthetic control group, reducing standardized mean differences between 7(a) and non-7(a) firms to below 0.05 for key covariates, ensuring robust causal inference.
- •The marginal impact of PPP loans on employment retention, financial stress alleviation, and commercial credit improvement was smaller for firms with 7(a) experience compared to non-7(a) counterparts, suggesting a potential misallocation of funds.
- •The research identifies a tension between universal liquidity needs and niche transmission channels, highlighting the need to decouple verification from historical lending relationships in future crisis responses.
Practical Implications
- •The findings suggest that future emergency lending programs should consider establishing a direct "public option" rail that bypasses bank underwriting for standardized relief to reduce intermediation frictions.
- •Implement Algorithmic Tranching or Lottery-Based Processing within the first window (e.g., the first 72 hours) rather than strictly processing applications linearly to prevent the crowding-out effect observed in April 2020.
- •Invest in Digital Public Infrastructure (DPI), such as Open Banking APIs and a standardized Digital Business ID system, to reduce information asymmetry and enable lenders to verify a firm’s existence and scale instantaneously.
- •Future emergency facilities should adopt a Tiered Origination Fee Structure that compensates lenders based on the complexity of verification rather than just loan size to align banks' profit motive with the social goal of equitable distribution.
- •Policymakers should prioritize developing pre-qualification mechanisms based on administrative tax data to streamline the application process and ensure that emergency liquidity reaches the most vulnerable businesses rapidly.