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In this paper we analyze the impact of government and private ownership of banks on firms' probability innovating. We estimate firms' decision to innovate and their selection of a main lender for a sample of 9000 German manufacturing companies. Since these two decisions may be made simultaneously, we use the number of private and government bank branches located in close proximity to our sample firms as an instrument for the selection of each firm's main lender. We find that the probability that a firm will innovate is about 10 to 13 percent higher if the main lender is a private bank, compared to if it is a government bank (after controlling for firm characteristics and selectivity bias). Furthermore, we analyze whether the existence of state-owned banks impacts the aggregate level of corporate innovation. To do so, we focus on geographic regions that are covered by state-owned banks experiencing a distress event. Given that local politicians refrain from bailing out state-owned banks if the distress event occurs before an election, the timing of distress events over the electoral cycle provides us with exogenous variation in the future presence of state-owned banks in these regions. We document a higher level of corporate innovation in regions whose state-owned banks experienced a distress event right before an election as compared to regions whose state-owned banks experienced a distress event after the elections. Thus, extensive government involvement in the allocation of credit comes at the cost of lower corporate innovation and therefore of economic development.