Academic interest in the role of trade finance has grown in the context of the financial crisis of 2008-09 and the subsequent economic downturn, just as policymakers’ interest was once caught by the Asian financial crisis (IMF 2003).
The ‘trade finance’ hypothesis has gained popularity among some economists in their research into plausible explanations for the Great Trade Collapse of late 2008 to late 2009, when global trade outpaced the drop in real GDP by a factor of 12, a figure much larger than anticipated under standard models. The validity of this hypothesis has often been discussed on Vox: Eichengreen and O'Rourke (2012) summarised that "the roots of this collapse of trade remain to be fully understood, although recent research has begun to shed light on some of the causes” (cf. Baldwin 2009, Amiti and Weinstein 2009; as well as Chor and Manova 2009). While most authors agree that the fall in demand has been largely responsible for the drop in trade flows, the debate focused on the extent to which other potential culprits, such as trade restrictions, a lack of trade finance, vertical specialisation, and the composition of trade may have played a role.
Clarifying the link between finance and trade
The ‘trade finance’ hypothesis is based on the intuition that major disturbances in inter-bank markets are hit by contagion of the supply of short-term trade credit, which in turn is linked with trade. The dependence of trade on short-term financing is explained by the fact that little international trade is paid in cash, and that the very existence of a time lag (on average 90-100 days) between the export of goods and the payment, justifies the need for credit and/or a guarantee. Furthermore, non-bank intermediated, inter-firm credit is often insured. Thus, in almost all cases the financial sector is involved in an international trade transaction through credit, guarantee or credit insurance.
From correlation to causality
Empirical work on trade finance has been limited by the lack of a comprehensive dataset, despite high qualitative information provided by market surveys on market trends and structure (ICC 2009, IMF-BAFT 2009). However, progress has been made within the academy in highlighting some link between financial conditions, trade credits and trade at the firm level. We have established the causality between firms' exports and their ability to obtain credit and the health of their banks (Amiti and Weinstein 2011); Bricongne et al. (2012) demonstrated that export-oriented firms in sectors more dependent on external finance have been most affected by the crisis; while Manova and Chor (2009) showed that the cost of external finance may prevent firms that are originally fit to export to actually do so. At the macro level, the OECD (Korinek et al. 2010) found a strong statistical relationship between insured short-term trade credit, as a proxy for total trade finance, and trade flows. When extending the same dataset over a full cycle, 2005-2012, a strong correlation is found between insured trade credit and trade flows (cf. Figure 1).
Figure 1. The relation between imports and insured trade credits in million US$ (averaged over all countries)
Our paper attempts to identify the effect of insured trade credits on trade at the macro level, hence moving ‘from correlation to causality’, using the Berne Union database, the largest available on trade credit. For the significance of macroeconomic analysis, it is important that the total amount of trade credit recorded annually by the data (close to $1.5 trillion for 100 countries) is somewhat proportionate to trade flows ($15 trillion annually for global merchandise trade) and the overall credit in the countries tested. We used a two-stage approach to link up global economic and financial conditions (GDP and liquidity) and trade credit availability, in the first stage; and trade credit availability and trade flows (imports since the breakdown of trade credit data is by destination country), in the second. This approach is aimed at avoiding endogeneity problems linked to reverse causality between trade credit and trade, as the volume of trade demand impacts on the demand for trade credit, and trade credit availability impacts trade as well. Besides the data on insured trade credits, the Berne Union data also contains information on claims on unpaid trade credits, which measures the actual risk of trade credit insurance.
How trade credit is affected by the crisis
Under the first stage, the study finds that the volume of insured trade credit available is affected by overall economic and financial conditions over a full economic cycle – from the upswing of 2005 to the peak of the financial crisis in 2009, and the stabilisation of activity in 2010-11. Trade credit is determined by the level of liquidity in the economy and by GDP as a measure of national income. The risk measure of trade credit insurance (claims paid on defaults of payments) has a small but strongly -significant effect on trade credit availability. Hence why export credit insurers seem to adjust their supply of trade credit insurance to changes in the risk environment but at the same time try to keep the supply stable.
The second stage of our study aims to introduce trade credit as a determining factor in the standard import equation, which includes, as described by the economic theory, GDP/national income and real effective exchange rates. Trade credit is found to be a significant and robust determinant of imports, with elasticities being stable and robust to tests around 0.4-0.5%. Real GDP and relative prices of foreign and domestic goods, the two traditional explanatory variables of standard import equations, also come out as the strongest determinants of imports.
Although, as in all empirical work, results must be treated with caution, these results stress the importance of trade finance for international trade both in crisis and in non-crisis periods,and we argue that these results are robust over a full cycle. The policy lesson to be drawn is that market incentives for supplying trade credit must be maintained at a high level, particularly during the current period of ‘deleveraging’ of the financial system. It should also be stressed that trade credit statistics need to be greatly improved, so as to be able to test the full set of global trade finance transactions against global trade.
Auboin, Marc and Martina Engemann (2012), "Testing the Trade Credit and Trade Link: Evidence from Data on Export Credit Insurance", WTO Working Paper 2012-18, Geneva.
Amiti, Mary, and David E Weinstein (2009), “Exports and financial shocks: New evidence from Japan”, VoxEU.org, 23 December.
Amiti, Mary and David E Weinstein (2011), "Exports and Financial Shocks", The Quarterly Journal of Economics, 126 (4), 1841-1877
Baldwin, Richard (2009), The Great Trade Collapse: Causes, Consequences and Prospects, ebook, VoxEU.org, 27 November.
Bricongne, Jean-Charles, Lionel Fontagné, Guillaume Gaulier, Daria Taglioni, and Vincent Vicard (2012), "Firms and the global crisis: French exports in the turmoil", Journal of International Economics, 87, 134-146.
Chor, Davin and Kalina Manova (2012), “Off the Cliff and Back? Credit Conditions and International Trade during the Global Financial Crisis”, Journal of International Economics, 87, 117-133.
Eichengreen Barry and Kevin H O'Rourke (2012), "A tale of two depressions redux", VoxEU.org, 6 March.
ICC (2009), "Rethinking Trade Finance 2009: An ICC Global Survey", ICC Banking Commission Market Intelligence Report, Document No. 470-1120 TS/WJ 31, March.
IMF (2003), “Trade Finance in Financial Crisis – Assessment of Key Issues”, Seminar Document, IMF Conference on Trade Finance, Washington, DC, 15 May,.
IMF-BAFT Trade Finance Survey (2009), "Survey Among Banks Assessing Current Trade Finance Environment".
Korinek, Jane, Jean Le Cocguic and Patricia Sourdin (2010), "The Availability and Cost of Short- Term Trade Finance and its Impact on Trade", OECD Trade Policy Papers, 98.