The Real Effects of Credit Constraints: Evidence from Discouraged Borrowers

Abstract

We use a new survey-based data set of 7,345 firms in 9 euro area countries over the period 2005-2015 to analyse the characteristics and behaviour of discouraged borrowers. We find that i) in their discouragement decision, firms trade-off their expected return on investment with the effective cost of borrowing (interest rate, opportunity costs, application costs) given their likelihood of rejection (firm risk). Firm risk matters significantly less when banks make more screening errors. ii) We predict the approval likelihood of discouraged firms and find considerable heterogeneity. iii) Comparing discouraged firms to applying firms of the same approval likelihood, we find strong negative effects of discouragement on investment (-11pp), employment (-4pp), added value (-5pp) and total assets (-6pp) growth due to the lack of bank financing. iv) Finally, we exploit a legal change in Belgium that reduced the application costs for firms. We find that the probability of being discouraged nearly halved for firms in Belgium after the introduction of the law compared to similar firms in other countries.

Keywords: Discouraged borrowers, survey data, real effects, natural experiment

JEL Classification: G01, G10, G30, G32