The collapse of Lehman Brothers in September 2008 is widely viewed as the spark that triggered the global economic crisis – what has come to be known as the “Great Recession.” Global credit markets froze, and this may have affected the specialised financial instruments – letters of credit and the like – that help grease the gears of international trade finance. Some analysts view this as contributing to the drop in global trade that occurred between the third quarter of 2008 and the second quarter of 2009 (Auboin 2009).
Careful research on historical episodes does reveal a link between credit problems and trade; see especially Amiti and Weinstein (2009) on the 1997 Asian crisis, and Iacovone and Zavacka (2009) on historical bank crises. Evidence presented in this chapter, however, suggests that declines in global trade finance have not had a major impact on trade flows. While global credit markets in general did freeze up, trade finance declined only moderately in most cases. If anything, US cross-border bank financing bounced back earlier than bank financing from other sources. Trade financing had at most a moderate role in reducing global trade.
It is challenging to disentangle supply and demand when it comes to trade and trade financing. Trade and trade financing plummeted; how can one know which caused which? (See Box 1 on the mechanics of how trade is exposed to financing shocks.) Much of the difficulty lies in the paucity of data.
The best available measures of trade financing add up to little more than 10% of global export values. Yet all exports must be financed, if only by the exporter itself. This means that the global reduction in trade financing must match the global reduction in exports.
As mentioned, there are specific historical estimates of the impact of financial crises on trade. For example, Amiti and Weinstein (2009) use Japanese firm-level export data matched to the performance of the firms’ banks to show that a damaged bank harmed its customers’ exports even more than its customers’ local sales. Drawing lessons, however, is perilous. The epicentre of this crisis was the global credit market, so the situation of global trade financing may be very different this time.
New evidence on trade financing
- This section compares the timing and regional composition of global merchandise exports with available data on trade financing. The comparisons highlight several facts:
- Cross-border financial flows declined substantially from all sources. Declines of US-based financing were neither particularly early nor disproportionately large.
- Reduced trade financing played a moderate role in the trade decline. Banks and suppliers judge reduced trade financing as the number two contributor to the decline in global exports, after falling global demand.
- The crisis has led to a compositional shift in trade financing. Because of heightened uncertainty and increased counterparty risk, exporters shifted away from risky open accounts towards lower-risk bank-intermediated financing and export credit insurance.
- Trade and its financing rose in the second quarter of 2009 for both developed and developing countries. US-sourced trade financing may have returned to markets relatively early.
- Development banks and government agencies worldwide have played an important role in improving access to trade financing, aiding the recovery of trade.
Box 1: Common types of trade financing and the risk for exporters
Worldwide, firms exported about $16 trillion of goods in 2008. Firms finance the majority of exports through open accounts, i.e. the importer pays for goods after they are delivered – just as is the usual practice for sales among firms in the same nation. This is the riskiest form of financing for an exporter (see diagram below). Estimates vary, but sources report that open accounts are used for between 40% and 80% of world trade (Scotiabank, 2007 and ICC, 2009a). Cash-in-advance, which is the least risky form of financing for exporters, accounts for a small share of total financing.
Banks finance the remaining 10% to 50% of global trade. Most bank financing involves a letter of credit; a transaction in which a bank assumes the non-payment risk by committing to pay the exporter after goods have been shipped or delivered. This method provides greater security to the exporter, and is particularly popular with small firms and in developing countries. Regardless of the type of financing used, exporters can also buy export insurance to reduce risk; about 9% of world trade was insured in 2008
The role of bank financing is increased if one includes working-capital loans, i.e. short-term loans used to buy the inputs necessary to produce goods ordered by foreign customers. Working-capital loans are more important for financing export shipments than for domestic shipments, because of the increased time between production and payment for exports. (Amiti and Weinstein, 2009)
Trade and financing rose and fell together
Nominal global merchandise exports fell 32% between the second quarter of 2008 and the same quarter in 2009. Figure 1 breaks out the changes in more detail for the US, other developed countries, and emerging markets. Developed countries led the downturn, with export declines beginning in the third quarter of 2008. Emerging markets had a sharper downturn and faster recovery. Relative to other countries, US trade changes have been more gradual, with a shallower decline through the first quarter of 2009 and smaller gains in other periods.1
The decline in global banking activity preceded the failure of Lehman Brothers in September 2008, and so preceded the merchandise trade decline (Figure 2). The decline in global cross-border lending, and the subsequent decline in domestic lending in most countries, directly reduced the availability of funds for trade financing. Domestic lending also decreased throughout the world; for example, US commercial and industrial loans began to decline in the first quarter of 2009 (Federal Reserve, 2009). US-based international financial outflows recovered earlier than those of other countries, illustrating a return to interbank dollar-denominated lending, and highlighting the need for dollar funding even as real GDP around the world continued to contract (McGuire and von Peter, 2009).
Figure 1. Global merchandise exports, 2007:Q1 to 2009:Q2
Source: IMF's International Financial Statistics.
Figure 2. External positions of banks, 2007:Q1 to 2009:Q2
Source: Bank for International Settlements
Cross-border lending (Figure 3) is more directly related to trade financing than global financial “positions”, which include categories such as bank holdings of securities. Because much of trade is dependent on short-term lending (either directly through bank-intermediated export financing, such as letters of credit, or indirectly through working capital financing), the decline in short-term banking activity is also an important indicator (Figure 4). The key conclusion from inspection of these charts is that:
- The contraction of financial flows mirrors, but was shallower and more protracted than the decline in merchandise trade.
Figure 3. Loans received, 2007:Q1 to 2009:Q2
Source: Bank for International Settlements
Figure 4. Short-term financing received, 2007:Q1 to 2009:Q2
Source: Bank for International Settlements
Strong demand supported trade financing during the crisis
In many ways, the changes in trade financing during the crisis reflect conditions in overall credit and banking markets during the period. The cost of trade financing, for example, briefly reached several hundred basis points (bp) in some markets, reflecting abnormally high financing costs throughout the financial system during in the fourth quarter of 2008. Availability declined and credit standards tightened for all types of financing to firms worldwide in the period.
Trade financing does have some characteristics that differ from other types of financing. Trade financing is generally priced as a share of the value of goods shipped, so trade financing is more directly tied to the level of exports than are other financial markets, and trade financing generally reflects the seasonality exhibited by a country’s exports. Furthermore, as discussed below, global demand for trade financing increased during the crisis, in contrast to falling demand for other corporate financing (ECB 2009).
These differences affected the timing of the decline in trade financing. Although overall financial flows declined before the trade collapse, trade-specific financing moved together with trade. Short-term export credit insurance exposure is a measure of the amount of trade financing provided by countries.2 Such insurance fell by 22% between the second quarter of 2008 and the same quarter of 2009. Trade financing debt incurred by countries is an imperfect proxy for the amount of financing that countries receive.3 Such debt fell by 12%, a considerably smaller decline than for credit insurance provided.
Figure 5. Export credit insurance exposure, 2007:Q1 to 2009:Q2
Source: Berne Union through the World Bank's Joint External Debt Hub.
Figure 6. Trade financing debt incurred by country, 2007:Q1 to 2009:Q2
Source: Berne Union through the World Bank's Joint External Debt Hub.
Figure 7. Drop in trade financing smaller than drop in exports, 2008:Q2 to 2009:Q2
Source: World Bank, IMF, and Berne Union through the World Bank's Joint External Debt Hub.
Comparing Figures 1, 5, and 6 the key observations are:
- Quarterly declines in trade financing generally, but not always, were smaller than the respective export decline.
- Figure 7 shows that the 4-quarter decline in either measure is smaller than the decline in trade for all regions except Latin America and the Caribbean.
Because much of trade financing is not distinguishable in official statistics – and the available data account for only about 10% of total global trade – data comparisons are intrinsically imperfect and incomplete. To address this, the IMF and WTO have sponsored surveys of global participants in the trade credit world. We turn now to a summary of the key findings from six recent surveys of international banks, suppliers, and government agencies.
Surveys show that declines in trade financing contributed directly to the decline in global trade in the second half of 2008 and early 2009. In general:
- Banks and suppliers report that trade financing is the number two cause of the global trade slowdown, after falling international demand (Table 1).
- Among international suppliers, 30% cited reduced trade financing as the key factor in lower foreign sales.
- Separately, 57% of banks reported that lower credit availability contributed to declining trade earlier in the crisis, but this share fell in later surveys.
Table 1. Trade financing was the number two reason for declining exports
Sources: IMF/BAFT (2009a), IMF/BAFT (2009b) and World Bank (2009).
Surveys confirm the trends shown in Figures 5 and 6 regarding the timing and regional distribution of trade financing during the crisis.
- Banks reported that the global impact of the financial crisis on trade financing peaked in the first half of 2009.
- Regarding differences across countries, surveys agree that Europe and North American experienced a larger decrease in trade financing than other geographic regions (with the exception of Eastern Europe) early in the crisis.4
By mid 2009, however, some emerging markets were experiencing the detrimental effects of reduced financing, with Eastern Europe still declining and Africa not yet recovering, although Latin America had stabilised and expectations for most of Asia were positive (ICC 2009b).
Early in the crisis, rising uncertainty increased demand for some trade financing, even as banks reduced supply. After September 2008, the risks of exporting and financing rose substantially because of downgraded credit ratings of firms, banks, and countries. Macroeconomic difficulties also mattered – declining GDPs, fluctuating exchange rates, and falling prices.
Demand for export credit insurance rose, and the covered value has risen for capital goods during the crisis despite substantial trade declines (Berne Union 2009b). Surveys show:
- Nearly half of banks surveyed experienced increased demand for products such as letters of credit, while banks wanted to restrict financing to limit lending risk.
- Most surveyed banks (47% to 71%, depending on the survey) reduced the supply of trade financing in the last quarter of 2008. For example, the value of letters of credit fell 11% in that quarter even as prices on those instruments rose.
- Increased demand and reduced supply combined to drive trade financing prices higher during the crisis.
- Banks raised prices throughout the crisis, with substantial increases in the price of letters of credit (70 bp) and export credit insurance (100 bp).
- The increase reflects only the price above banks’ own cost of financing, which moved sharply higher before falling later in the crisis (Bloomberg, LIBOR). Even so, the survey results do not appear to match the widely reported examples of 300 to 500 basis point increases that occurred in some markets at the height of the crisis.
- Surveys report that trade financing conditions had improved or stabilised by the second quarter of 2009. Although prices remain high, financing costs are not perceived as being a major impediment to trade, and trade financing remains the cheapest form of financing available to many companies.
Multilateral support efforts
An important reason for the recovery of trade financing is the implementation of much of the $250 billion in additional trade financing announced at the April G-20 meeting. Surveys and government reports show that the additional liquidity provided by multilateral development banks (MDBs), national governments, and export credit agencies is playing a positive role.
MDBs have announced or put in place over $9 billion in new financing (Table 2). The short maturity of most trade financing will allow these funds to be rolled over multiple times per year, providing more than $80 billion in new trade financing between 2009 and 2011. A majority of surveyed banks (55%) were utilising trade facilitation programmes implemented by MDBs by the summer of 2009 (ICC 2009b).
National governments have also increased availability of trade financing. For example, 15 of 18 APEC countries surveyed have expanded trade financing programmes, most commonly through additional export credit insurance or working capital guarantees (APEC 2009). The total value of new government measures is not known, but among major economies, the US announced its intention to provide $4 billion in annual new short-term insurance and $8 billion in longer-term financing for the export of US goods and services to emerging markets; China announced $8 billion of additional annual financing; and Japan will provide up to $22 billion over the next two years.
Table 2. Additional trade financing through MDBs, $ million
Sources: World Bank, EBRD, ADB, and IDB.
The state of trade financing appears to be largely independent of US developments. However, because most trade is probably financed by open accounts (i.e. customers pay after receiving the trade goods, just as they do for most domestic purchases), firms rather than banks are providing most of the trade financing. A recovery in exports will require improvement in general financial market conditions, particularly to provide working capital to exporters. Here, US financial market conditions may play an important role.
Disclaimer: This piece solely represents the views of the authors and does not represent the views of the US International Trade Commission or any of its Commissioners.
1 As noted, the trough in real US exports occurred later, in the second quarter, as did the trough in real world trade (CPB, World-Trade Database), but nominal values are presented here for comparison with the financial data below.
2 The United States, Germany, Italy, and France are the top providers of this insurance, accounting for about 25% of the global total. Globally, firms and agencies had close to $900 billion of such exposure prior to the crisis. About 90% of the credit guarantees are provided by private companies. (Berne Union 2009a)
3 The figure includes only short-term non-governmental trade financing debt, which had a global value of $572 billion prior to the crisis. Debt depends on trade financing received as well as repaid, so debt may under-represent the decline in trade financing in countries that experienced fiscal difficulties during the downturn.
4 The number of international transactions relayed through the SWIFT financial telecommunications system (both received and supplied) fell in all regions in 2008. This may indicate an early decline in trade credit volume not visible in data on trade credit values. (ICC 2009a)
5 Not all announced commitments will be fully realized. For example, the U.S. commitment led to a doubling in the value of short-term financing in the first 9 months of its fiscal year 2009 relative to the same period in 2008. Medium- and long-term guarantees did not increase, however. (Ex-Im Bank 2009)
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