Discouraged Borrowers and Sentimental Shocks

We quantify, for the first time in the literature, the three channels affecting discouraged bank borrowers through pessimistic sentimental shocks. While the existence of discouraged borrowers is not a new phenomenon, our research puts forward an analytical approach that places sentiment-driven shocks at the forefront of understanding these behaviors. Using a sample of around 90,000 firm-level observations from European SMEs, we find that a higher level of pessimistic sentimental shocks from credit demand, credit supply, and, to some extent, inflation is positively related to the probability of firms being discouraged. These results are, in general, robust to endogeneity, selection bias, and alternative specifications. Our findings unveil the profound impact of sentiment-driven factors on the borrowing behavior of businesses and have practical implications for both policymakers and financial institutions.