The authors explore the factors that discourage small firms from applying for bank loans
in nine European countries. Borrower discouragement can be explained by firm
characteristics, macroeconomic factors, and banking industry factors. The results also
show that a borrower’s perception of a bank’s unwillingness to provide
credit discourages the borrower from applying, especially during a financial crisis.
How Is This Research Useful to Practitioners?
When evaluating loan applications, banks rely on borrowers’ business and financial
information. Compared with larger firms, small and medium-sized enterprises (SMEs) have
greater difficulty and higher costs in providing this information and thus face higher
hurdles in obtaining bank financing.
Even if they have potentially profitable projects, SMEs may be discouraged from applying
for debt financing because of worries that they may be refused. As a result, SMEs obtain no
funding for their projects and banks lose the opportunity to make potentially profitable
loans. Discouraged borrowers lead to inefficient capital flow and a suboptimal level of
The fear-of-refusal problem arises from information asymmetry. Because borrowers have more
information about their financial prospects than do lenders, banks are unable to clearly
distinguish between good and bad SME borrowers and may make screening errors (i.e., reject
good borrowers but accept bad ones).
The authors investigate the determinants of borrower discouragement by looking at three
types of explanatory factors: firm-level characteristics, macroeconomic and regulatory
factors, and banking industry factors. They find that smaller and younger firms, as well as
those with higher debt ratios and less capital, are more reluctant to apply for bank loans.
The authors also explore how SME perceptions affect their decisions. When SMEs perceive that
banks are unwilling to lend or when they have liquidity pressure, they are discouraged from
applying. When firms have a strong need to borrow, however, they are less likely to be
discouraged, because the acute need to survive outweighs the discouragement.
Another important finding is that when the banking sector is more concentrated, borrowers
are less likely to be discouraged. A less competitive banking environment provides
incentives for banks to build relationships with borrowers, which reduces information
asymmetry, resulting in less discouragement. In addition, when there is stress in the
financial sector, such as higher government bond yields and less private market credit,
borrowers are more likely to be discouraged, which shows the procyclical nature of debt
The results from this study imply that merely increasing the supply of financing by the
government does not encourage firms to borrow. More policy and regulatory measures are
needed to overcome the barriers that discourage borrowers.
How Did the Authors Conduct This Research?
The authors empirically investigate the factors that cause SMEs to become discouraged from
seeking financing. The authors use a sample of SME responses to a particular questionnaire:
“Survey on the Access to Finance of SMEs” (SAFE), which was conducted by the
European Commission and the European Central Bank. The sample covers nine European countries
over 2009–2011. Particular firms in the sample were randomly selected from the Dun
& Bradstreet firm database. The firms selected all had fewer than 249 employees. After
excluding firms in the financial services, nonprofit, and public administration sectors,
there are 6,287 firm-level observations. Cross-country differences are observed: Firms in
Ireland have the highest rate of discouraged borrowers (44%); firms in Spain have the lowest
The authors use binomial logit regression to analyze the survey responses. Survey responses
are either (1) yes, applied for financing, or (2) no, did not apply due to possible
rejection. To explain these responses, the authors use four types of explanatory variables:
firm characteristics, macroeconomic conditions, regulatory factors, and banking industry
factors. Industry sector and time dummy variables are included for control.
The authors’ methodology is novel in the sense that the owner’s
“perceptions” of the firm’s condition and the bank’s willingness
to lend are considered. The results are significant, suggesting that both objective factors
and subjective perceptions affect the SME’s decision whether to apply for a loan.
This survey is useful. When good borrowers are discouraged from applying for loans, a
government’s expansionary monetary policy becomes less efficient and effective
because SMEs do not make potential investments.
Readers should note that self-selection of discouragement may not be bad if only bad
borrowers are discouraged. This kind of discouragement makes the financing market for SMEs
One possible way to improve access to financing for good borrowers is to reduce the
likelihood that borrowers will become discouraged—for example, by reducing the costs
incurred when applying for a loan. From basic economics, we know that resources are
allocated more efficiently when transaction costs are lowered. Thus, regulators might
consider simplifying loan application procedures and thereby lowering transaction costs.
Because of information asymmetry, banks are more likely to make screening errors and thus
disappoint good borrowers. Reducing information asymmetry can also help reduce borrower
discouragement. In recent years, technology has been deployed to lower information costs.
For example, the credit performance of an SME can be synchronized both in a timely manner
and anonymously among financial institutions. In addition, “big data”
techniques can be used to analyze the cash management, trade records, and creditworthiness
of SMEs’ trading partners as well as provide a tailor-made debt solution. By using
technology, banks are likely to make fewer screening errors in reaching loan decisions and
good borrowers are less likely to be discouraged.