Discouraged Bank Borrowers: A Real Options Perspective

A stylized empirical fact is the rather substantial portion of SMEs who although in need of bank credit, do not apply for a loan, due to fear of possible rejection. Non-applying in-need borrowers are known as 'discouraged borrowers'. We propose a new perspective for modelling discouraged potential bank borrowers, based on a Real Options explanation. A loan application decision is clearly not a 'now-or-never' decision, since the decision can be delayed. Hence the firm may be considered as holding a Real Option. Employing firm-level survey data that allow us to identify discouraged firms, as well as, constructing Real Options proxies we test whether discouragement is explained by Real Option factors. Our approach takes into account the selectivity, subject to which the discouragement phenomenon is observed, by modelling discouragement using a Bivariate Probit with selection setup. Our results, provide empirical support for the presence of Real Options effects in the discouragement process.