Back to Borrowing? Perspectives on the Arc of

Discouragement

Presentation of initial findingsBBA 18th December 2013

Stuart Fraser

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.

Arc of discouragement

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.

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.

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

DB model • A productivity threshold () separates

businesses with capital demands () from those without capital demands (). – Location of 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 ()

separates the discouraged, whose perceived chances of success fall below the threshold (), from the non-discouraged ().

• 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 ()

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 () and who are not

discouraged ().– Non-seekers: businesses without capital demands (). – Discouraged borrowers: businesses which have capital demands () but

which do not apply because their perceived chances of a successful application are low ().

• The model predicts the existence of a fourth new type:– Discouraged non-borrowers (DNBs): businesses which (no longer) have

capital demands () and which are (or have been) discouraged ().• This is a kind of entrenched/latent discouragement.

– DNBs have slipped into a ‘slough of despond’.

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

2004 2008 20092011 Q1/2 2011 Q3 2011 Q4

2012 Q12012 Q2

2012 Q32012 Q4

2013 Q12013 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

-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 ofbank lending

Experiences of peers

Satisfaction with bank Other effects

Impacts on gaps between perceived and actual success probabilities (% points)

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).

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%

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Issues with application process Approach by bank about lending(pro-activity)

Awareness of support Other

Key impacts on application costs (% points)

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 15years

50K-74,999 100K-249,999 500K-999,999 2-4.9m 15-24.9m

Business age Sales

Firm impacts on application costs

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.

Emerging messagesImproving 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).

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…

5.7

5.3

3.8

5.0 4.9 4.9

3.93.6

3.0

1.8

2.3

4.04.3

3.4

2.5

3.43.1

3.23.1

2.5

2.0

3.4

3.0

2.1

2.8

2.52.3

1.5 1.5 1.4

0.6

-2.1

0.40.6 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 2011Q1/2

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