This document summarizes initial findings from research into discouraged borrowers (DBs) in the UK. It defines DBs as businesses that have financing needs but do not apply for loans due to perceived low chances of success. The research aims to understand why DBs exist and what could encourage them to borrow again. Key findings include: - DBs tend to be smaller, younger, riskier businesses compared to other firms. - Discouragement occurs when perceived application costs outweigh perceived chances of success. Improving perceptions and lowering costs could help. - Perceptions are sensitive to bank satisfaction and peer experiences. Support and bank outreach also impact costs. - Younger, smaller firms face higher

1. Back to Borrowing?
Perspectives on the Arc of
Discouragement
Presentation of initial findings
BBA 18th December 2013
Stuart Fraser

2. Introduction
• Key research questions:
– Why are there DBs?
• Develop understanding of the mechanisms of discouragement.
• (Mis)perceptions of chances of making successful applications vs
perceived application costs.
– What might encourage DBs back to borrowing?
• Improving perceptions and/or lowering application costs?
• Mixed methodology:
– Econometric analysis speaks to the ‘big picture’.
• Analysis using UKSMEF (2004-2009) and SMEFM (2011 Q1/2-2013
Q2).
– Depth interviews/case studies (BDRC) enable a closer
perspective.
• Emerging messages for:
– Banks.
– Support agencies.
– Government.

3. Arc of discouragement

4. Who are DBs?
• DBs are examined relative to two other groups:
– Businesses that have sought finance (‘seekers’).
– Businesses that say they have no need for finance
(‘non-seekers’).
• DBs are:
– Smaller in terms of sales and business assets than
seekers if not non-seekers.
– Smaller in terms of the number of employees than
both seekers and non-seekers.
– Younger than seekers/non-seekers.
– Riskier than seekers/non-seekers.

5. Who are DBs?
• The owners of DBs are:
– Less wealthy than owners of seeking/non-seeking
businesses.
– Less experienced than owners of seeking/non-seeking
businesses.
– Younger than owners of seeking/non-seeking businesses.
A typical DB: has sales below £250,000, business assets of £10,000;
fewer than 10 employees; is aged less than 7.5 years; has an
average/above average risk rating; is a ‘real estate/business services’
or construction business; is located in London, the West Midlands or
East of England; and has a white male owner aged 31-50 with 15 or
fewer years of experience and a personal wealth of around £100,000.
• Few differences between the indirectly and directly
discouraged.
– Indirectly discouraged are slightly smaller/younger/riskier.

6. Why are there DBs?
• We already know that DBs tend to be
smaller, younger and riskier
businesses.
• We know less about the mechanisms
of discouragement (see right).
• What factors shape the perceived
prob. of success?
– Previous experiences with lenders.
– The borrowing experiences of peers in
business.
– Media reports of bank lending.
• Are there cognitive biases in
perceptions?
– We can’t tell just looking at the
associates of discouragement.
• We need a model to disentangle the
perceived prob. of success from
application costs.
– This matters from a policy perspective.
– Improving perceptions/confidence vs
lowering costs/‘hurdles’.
Discouragement occurs when the
perceived cost of making a loan
application outweighs the perceived
chances of the application being
successful.
Application
costs
Perceived prob.
of success

7. DB model
• A productivity threshold (𝜃0)
separates businesses with capital
demands (𝜃 ≥ 𝜃0) from those
without capital demands (𝜃 < 𝜃0).
– Location of 𝜃0 depends on availability of
internal finance (need) and interest
rate.
– In a perfect capital market decision to
apply for finance depends only on need
and interest rate (hence all businesses
with capital demands are seekers).
• In imperfect capital markets
information asymmetries mean that
loan applications are costly.
– A perceived success threshold (𝜔0)
separates the discouraged, whose
perceived chances of success fall below
the threshold (𝜔 < 𝜔0), from the non-
discouraged (𝜔 ≥ 𝜔0).
• The location of this threshold
depends on perceived application
costs (‘hurdles’) including:
– Perceived cost/hassle of applying (+)
– Perceptions that the bank will ask for
security/terms and conditions (+)
– Support ()

8. DB model
• The model predicts the existence of 3 known types of
business in the context of borrowing decisions:
– Seekers: businesses which have capital demands (𝜃 ≥ 𝜃0) and
who are not discouraged (𝜔 ≥ 𝜔0).
– Non-seekers: businesses without capital demands (𝜃 < 𝜃0).
– Discouraged borrowers: businesses which have capital demands
(𝜃 ≥ 𝜃0) but which do not apply because their perceived
chances of a successful application are low (𝜔 < 𝜔0).
• The model predicts the existence of a fourth new type:
– Discouraged non-borrowers (DNBs): businesses which (no
longer) have capital demands (𝜃 < 𝜃0) and which are (or have
been) discouraged (𝜔 < 𝜔0).
• This is a kind of entrenched/latent discouragement.
– DNBs have slipped into a ‘slough of despond’.

9. 0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
2004
2008
2009
2011 Q1/2
2011 Q3
2011 Q4
2012 Q1
2012 Q2
2012 Q3
2012 Q4
2013 Q1
2013 Q2
UKSMEF
SMEFM
43.0%
28.9%
5.9%
36.5%
32.4%
38.1%
35.3%
35.3%
33.6%
40.7%
37.7%
42.4%
79.6%
69.6%
55.9%
69.0%
64.5% 67.6%
66.3%
65.5%
61.8%
66.8%
64.9%
69.5%
84.0%
78.4%
68.8%
77.0%
75.9%
72.5%
77.9%
73.9%
69.3% 72.9%
69.0%
72.9%
Perceived probabilities of making successful applications
Perceived success probability (DBs) Perceived success probability (all firms) Actual success probability

10. -8.9%
-16.3%
-13.9%
-16.9%
1.9%
-2.4%
-16.3%
-25.6%
-23.3%
-26.7%
-7.8% -7.5%
-12.6%
-21.0%
-18.6%
-21.8%
-3.0%
-5.0%
-30.0%
-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
Fairly satisfied Neither/nor Not very satisfied Not at all satisfied Media coverage of
bank lending
Experiences of peers
Satisfaction with bank Other effects
Impacts on gaps between perceived and actual success probabilities (%
points)

11. Perceptions summary
• Perceptions vary with the economic cycle.
– State of economy affects perceptions (govt. role in
improving confidence?)
– Perceptions (for average SME if not DBs) may be currently
self-correcting as confidence returns.
• Perceptions are very sensitive to levels of satisfaction
with bank.
– Even being less than very satisfied can worsen perceptions.
– A key reason for dissatisfaction is previous rejection and
how this was handled (see qual. analysis).
• Very marginal negative impact of media coverage.
– Not a primary cause of poor perceptions (see qual.
analysis).
• Negative experiences of business peers more
significant (see qual. analysis).

12. 9.2%
11.1%
21.7%
28.0%
-4.3%
-2.2% -2.6%
0.9%
5.1%
12.0%
19.1%
0.0% 0.4%
11.7%
15.3%
-16.3%
-10.8% -10.9%
-5.2%
-10.5%
4.8%
6.9%
4.6% 5.8%
16.7%
21.7%
-10.3%
-6.5% -6.8%
-2.1% -2.7%
8.4%
13.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
Toocostly
Hassle
Securityrequirements
Termsandconditions
Approachbymainbank
Approachbyotherbank
AppealsProcess
EnterpriseFinanceGuarantee
FLS
Economicclimate
Debtaversion
Issues with application process Approach by bank about lending
(pro-activity)
Awareness of support Other
Key impacts on application costs (% points)

13. 0.5%
2.6%
-0.1% -0.4% -0.7%
-5.7%
-13.0%
-14.0%
-6.3% -6.6%
-14.8%
-11.4%
-16.3%
-18.4%
-17.4%
-18.6%
-26.8%
-29.8%
-24.7%
-34.3%
-7.2%
-4.4%
-8.2%
-9.4% -9.1%
-12.2%
-19.9%
-21.9%
-15.5%
-20.5%
-40.0%
-35.0%
-30.0%
-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
5.0%
1-2 years 2-5 years 6-9 years 10-15 years More than 15
years
50K-74,999 100K-249,999 500K-999,999 2-4.9m 15-24.9m
Business age Sales
Firm impacts on application costs

14. Application costs summary
• A number of issues related to the application process
increase costs.
– Perceptions of security requirements/T&Cs in particular.
• Being approached by a bank about lending significantly
lowers application costs.
– Especially an approach by your own bank.
• Awareness of the Appeals Process makes applying seem
more worthwhile.
– Awareness of EFG to a lesser extent.
• Concerns about the economic climate raise perceived
hurdles in applying.
– State of economy affects perceived success and hurdles.
• Higher hurdles too for younger and smaller businesses.
– Role for support agencies.

15. Emerging messages
Improving perceptions Lowering hurdles
Banks • Better customer service
(handling of rejections?)
• Greater pro-activity (approaching
businesses about borrowing
needs).
• Support with issues in application
process (perceived cost/security
requirements/T&Cs).
• Raise awareness of appeals
process.
Support agencies • Support (younger/smaller)
businesses with applications.
• Raise awareness of appeals
process.
Government • Policies need to improve
business confidence (not
just lower interest rates).
• Support (younger/smaller)
businesses with applications.
• Improve economic climate.
• Raise awareness of policies
designed to lower hurdles (e.g.,
EFGs).

16. Conclusions
• Reducing discouragement depends on both
improving perceptions and lowering hurdles:
– This matters because around 2/3rds of DBs might be
successful if they applied.
– Evidence of self-correction as confidence in economy
returns (see next slide).
• Existence/extent of DNBs merits further
investigation.
– DBs may be just the tip of the iceberg.
• Over to Shiona for a closer perspective on DBs…

17. 5.7
5.3
3.8
5.0
4.9 4.9
3.9
3.6
3.0
1.8
2.3
4.0
4.3
3.4
2.5
3.4
3.1
3.2
3.1
2.5
2.0
3.4
3.0
2.1
2.8
2.5
2.3
1.5 1.5 1.4
0.6
-2.1
0.4
0.6 0.7 0.6
-0.4
0.6 0.6
-0.1 0
-0.5
0.7
-0.2
0.3
0.7
-3
-2
-1
0
1
2
3
4
5
6
7
2004 Q4 2008 Q4 2009 Q4 2010 Q1 2010 Q2 2010 Q3 2010 Q4 2011
Q1/2
2011 Q3 2011 Q4 2012 Q1 2012 Q2 2012 Q3 2012 Q4 2013 Q1 2013 Q2
Discouraged Borrowers:2004-2013
DB any(%)
DB indirect(%)
DB direct(%)
GDP growth (%)
UKSMEF
SMEFM