Does the tone of central banker’s speeches discourage potential borrowers?

Ever wondered why some businesses, despite needing a financial boost, hesitate to apply for loans? It’s like they’re stuck in a game of cat and mouse with banks, needing credit but fearing rejection. Well, in the world of finance, this outcome in the credit market is known as the discouragement of potential bank borrowers. This fragility has both micro and macro-level impacts: a small business, eager to expand, but holding back from seeking the funds it needs to grow. It’s not just about their day-to-day operations; it’s about the ripple effect their hesitance sends through the entire economy. From the tiny cogs of their micro-level operations to the grand gears of national employment rates and GDP growth at the macro level, the impact is undeniable.

Then, the question arises: why? What drives a business’s decision to shy away from seeking the credit it so desperately needs? A new study by Dimitris et al. (2023) argues that discouragement may arise from behavioral factors shaping firms’ perceptions of the probability of rejection. More importantly, they show the tone of central bankers’ speeches as a main factor that may influence the sentiment of potential borrowers, reshaping the perceived rejection probability.

Central banks are akin to conductors of a financial orchestra, their speeches setting the tempo for market movements. Through addresses, central bankers not only articulate policy decisions but also depict economic landscapes and shape market expectations. And it’s not just the words themselves that carry weight; it’s the subtle nuances, the tone, and the emotions behind them that can truly sway the minds of market participants.

Previous research has hinted at the potency of these speeches, suggesting that they can influence not only what market players hear but also how they interpret it. For instance, Schmeling and Wagner (2024) demonstrate that a positive (negative) tone from central banks correlates with lower (higher) volatility expectations and decreasing (increasing) corporate credit spreads. Building upon this prior evidence, Dimitris et al. (2023) explore whether central bank communication, gauged by the tone content of central bankers’ speeches, impacts the likelihood of discouragement observed among a diverse sample of small and medium enterprises (SMEs) in the euro area.

To achieve this, Dimitris et al. (2023) access data from the “Survey on the Access to Finance of Enterprises” (SAFE), published by the European Central Bank (ECB), which provides restricted-access microeconomic data for over 8,500 SMEs. To start with, they create a binary variable based on the survey to reflect the firm’s money demand. This binary variable takes the value of one if the firm requires credit and zero otherwise. Subsequently, when the firm expresses a need for credit, the authors construct their dependent variable of “discouragement” by using the responses to a subsequent survey question: “Have you applied for a bank loan in the past 6 months?” The corresponding options in the questionnaire are: “(1) Yes, applied; (2) No, afraid of rejection; (3) No, sufficient internal funds; (4) No, other reasons; (5) DK/CA.” Among these, responses corresponding to the second option are assigned a value of one for the variable “discouragement”, while all other responses are assigned a value of zero.

The figure below illustrates the distribution of discouraged bank borrowers by country over the period 2009H2-2018H2. To gauge the tone of central bank governors’ speeches, the authors employ web scraping to gather 1476 speeches delivered by the eurozone member central bank governors between 2009 and 2018. After processing the text, the authors measure the tone of the speeches using the following method: TONE=(POS-NEG)/(POS+NEG) , where POS and NEG are the numbers of positive and negative word counts.

Distribution of discouraged bank borrowers by wave (across all countries)

Notes: This figure illustrates the distribution of discouraged bank borrowers by wave (across all countries). The horizontal axis represents survey waves (six-month periods) spanning from 2009H2 to 2018H2

Source: Dimitris et al., (2023).

The authors then proceed to estimate various pooled probit models by regressing the discouragement binary variable on central bank tones. It is noteworthy that across all regression analyses, the coefficient estimate of the “tone” consistently remains negative and statistically significant at the 5% level, with absolute values ranging between 0.025 and 0.063. This implies that a 1% increase in the measured tone corresponds to a 4.4% decrease in the propensity of businesses to withdraw their loan applications, indicating an inverse relationship between the tone of central bank governors’ speeches and the incidence of application withdrawals. Importantly, this result holds firm even when controlling for more additional variables.

Nevertheless, one might argue that the likelihood of withdrawing loan applications could also be influenced by the discrepancy in tone between the national central bank governors’ speech and that of the European Central Bank (ECB) governor. To address this concern, Dimitris et al. (2023) introduce another measure of tone divergence by subtracting the tone of the ECB from the tone of each national central bank. Upon regressing discouragement on this diverging measure, the authors discover a significant and positive marginal effect of tone divergence on borrower discouragement at the 5% level. Specifically, a 1% increase in tone divergence results in a 12.4% increase in the likelihood of a borrower being discouraged on average.

However, there is another concern regarding the possibility that the speeches of central bankers may reflect the state of the economy, potentially complicating the causal relationship in this study. To address this concern, the author regresses the tone of speeches on a set of macroeconomic fundamentals and utilizes the residuals as the “purified” measure of tone. The authors find that, using this “purified” tone as an explanatory variable, the result remains significantly negative.

As an additional robustness check, the authors also consider the frequency distortion. It is reasonable to conjecture that the frequency of speeches by central bank governors may influence the withdrawal behavior of domestic businesses. If governors deliver speeches more frequently compared to their counterparts, potential borrowers may reduce their attention to the speeches of central bank governors, resulting in a decrease in the withdrawal behavior of businesses. To address this concern, the authors conduct another regression on the frequency of a central banker’s speeches, which continues to show a negative and statistically significant effect.

So, does the tone of central banker’s speeches discourage potential borrowers? Absolutely! Effective communication plays a pivotal role in bolstering central banks’ ability to formulate sound policy decisions and enhances their credibility as public institutions. Dimitris et al. (2023) underscore the significance of central bankers’ communication in influencing firms’ decisions to seek bank loans. Indeed, central bank communication isn’t just about words; it’s about the signals they send, the confidence they inspire, and the decisions they shape. Remember, even a smile can carry weight, so it’s important to think twice before any action.

Chaoyi Chen


Anastasiou, D., Krokida, S.-I., Tsouknidis, D., & Drakos, K. (2023). Can the tone of central bankers’ speeches discourage potential bank borrowers in the eurozone? Journal of International Money and Finance, 139, 102950.

Schmeling, M., & Wagner, C. (2024). Does Central Bank Tone Move Asset Prices? Journal of Financial and Quantitative Analysis, 1–48.

Borítókép: pixabay.com

The post Does the tone of central banker’s speeches discourage potential borrowers? appeared first on Economania blog.

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