Abstract:This paper deals with the notion of organizational frictions in credit markets. We discuss a number of reasons for which functional distance -- the distance between the borrower and the bank's decisional center -- and the share of large banks in local credit markets could be good proxies for organizational frictions and bureaucratization of lending decisions. We apply our analysis to a sample of Italian SMEs. Since we do not have any information concerning individual loans, we can only build aggregate measures of functional distance and bank size at the provincial level. To control for possible endogeneity problems, our empirical exercises are conducted by instrumental variable techniques. We find that firms located in provinces where the local banking system is functionally more distant are statistically and economically significantly less inclined to introduce innovations. Furthermore, in such provinces credit rationing seems to be a more likely phenomenon and innovative firms are relatively more penalized. Conversely, we find that the market share of large banks is only rarely statistically significant and when it is such the economic impact is appreciably smaller than that of functional distance.