This paper analyzes the characteristics and behavior of discouraged borrowers. First, we show that, in the decision to apply for a bank loan or to be discouraged, firms trade-off their expected return on investment with the cost of borrowing (interest rate, opportunity cost, application cost) and their rejection likelihood. Second, we predict the approval likelihood of discouraged borrowers and find that a significant fraction would be able to get a bank loan if they would actually apply. Third, we exploit an exogenous legal change in Belgium that reduced firms’ loan application costs and find that this significantly reduced the probability of being discouraged for firms in Belgium relative to similar firms in Germany and France. Using this exogenous change in discouragement, we document strong negative effects of discouragement on investment, employment, and sales.

We explore the role of government initiatives fostering entrepreneurship—in the form of tax advantages and government support—in influencing the probability that entrepreneurial firms obtain bank credit and are not discouraged from applying for a loan. We propose that government initiatives fostering entrepreneurship should allow entrepreneurial firms to access more bank credit by reducing the risk incurred by lenders. We simultaneously estimate the probability of obtaining credit when a firm applies for a loan and the probability that the firm has been discouraged when it does not apply for a loan. In both cases we control for endogeneity. Our results are based on 18,872 observations (from the European Central Bank (ECB) SAFE dataset and Global Entrepreneurship Monitor – GEM) and show that government initiatives improve the probability of entrepreneurial firms obtaining bank credit but do not affect the probability of being discouraged from borrowing. The results also suggest that government initiatives fostering entrepreneurship are of most benefit to younger, smaller, high-growth, and more innovative firms that operate in contexts where the demand for, and accordingly the competition for, bank credit is strongest.