Borrower discouragement: the role of informal turndowns

Abstract

This research seeks to add to our understanding about discouraged borrowers by examining the roots of discouragement. It examines the role of informal turndowns in which a commercial lender verbally informs a SME owner that if a formal loan application were to be advanced, it would likely be denied. This aspect of demand-side constraints to accessing finance has received scant attention in research. The presence of discouraged borrowers could be evidence of a market imperfection; however, informal turndowns represent an efficient mechanism in SME debt markets providing an explanation for a type of borrower discouragement. This research finds more established firms are more likely to suspend formal loan applications through informal talks with their banks rather than being discouraged by their own judgement. In addition, those small business owners who have a satisfactory relationship with their banks are more likely to self-ration themselves rather than conduct an informal inquiry with their banks before deciding not to apply.