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24 August 2015

ECB working paper: The real effects of credit constraints - evidence from discouraged borrowers in the euro area

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This paper investigates the characteristics and behaviour of discouraged borrowers in the euro area. The results show that more borrowers are discouraged when the average interest rate charged by banks in a country is higher. Higher corporate tax rates, on the opposite, lead to lower discouragement.

According  to  the  literature,  discouraged  borrowers  are  firms  that  need  external  finance, but do not apply for a bank loan because they fear that their application will be rejected.  Due to the scarsity of data, it is rather difficult to document the relevance of discouraged borrowers for an economy and the impact of their status in terms of economic growth.  It is also difficult to empirically validate theoretical models that explain the presence of such type of borrowers. In this paper authors overcome these problems by using a unique dataset from the European Central Bank, which matches firms that participated in the Survey on Access to Finance of small and medium sized Enterprises (SAFE) with their financial statements.  From the information derived from the survey they directly identify discouraged firms, firms that applied for a bank loan and received the loan, and firms that applied for a bank loan but had their application rejected.  Furthermore, authors then use the information on the financial statements to explain the characteristics and behaviour of discouraged borrowers compared to both successful and rejected applicants.

Authors first explore how discouragement is related to the financial position of firms, once they control for other important factors linked to the business cycle and credit supply conditions.  They make use of a theoretical model (Kon and Storey, 2003) that states, in a nutshell, that firms will be discouraged to apply for a bank loan when their expected profits of investing the bank loan do not exceed the total effective costs of borrowing.

A  second  aim  of  the  paper  is  to  quantify  how  important  the  discouragement  effect  is  for  the economy.  Authors find that discouragement has real effects on firm employment and growth due to the lack of access to bank loans.

A third aim of the paper is to understand whether discouraged firms are risky firms according to their observed characteristics and, in particular, to make a prediction on their approval likelihood if they would have applied.  Authors do so by analysing the characteristics of those firms that applied and received a loan and they relate these characteristics to discouraged borrowers.  They find that the vast majority of discouraged borrowers (61%) would be rejected if they would apply, however,  there  also  exist  some  discouraged  borrowers  (8%)  with  a  high  likelihood  to  get  their loan application approved.  This is true when the discouraged firms are compared to approved firms in the same country only.  By contrast, the approval likelihood of discouraged borrowers shows a different story when they are compared to approved firms from all the countries in their sample.  For instance, in some countries (Belgium, Germany, Finland) the approval likelihood of discouraged  borrowers  increases  significantly  (from  8%  to  17%)  when  they  are  compared  with approved firms in countries like Greece or Spain.  The results indicate, from a new angle, that the banking sector in the euro area might not be strongly integrated.

From a policy perspective, even though authors find that only few discouraged borrowers would be likely to get an application approved, policy measures to help inform discouraged borrowers about their approval likelihood could be desirable if the cost of these measures is lower than the value that these few borrowers would create if they get their application approved.

Full working paper

© ECB - European Central Bank

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