The role of trade finance.

1.
RESEARCH
PAPER
The
Role
of
Trade
Finance:
Evidence
from
the
2008-­‐2009
Great
Trade
Collapse
University
of
Strasbourg
-­‐
EM
Strasbourg
Business
School
Masters’
in
International
and
European
Business
International
Finance
(EM375M53)
Academic
Year
2013-­‐2014
Professor
Dr.
Erasmus
S.
Kaijage
Daniel
PATINO
Student
Number
21210030
19th
of
December
2013

2. 1
TABLE OF CONTENTS
I. ABSTRACT………………………………..………………………………………….2
II. INTRODUCTION AND BACKGROUND……………………………….................3
III. RESEARCH PROBLEM, OBJECTIVES AND QUESTIONS…………………..…4
IV. EMPIRICAL LITERATURE REVIEW…………………………………...………..5
1. - The role of trade finance…………………………………………………………………….5
2. - Brief reference to the main trade finance instruments in use……………………….....6
2.1. - Documentary credits and trade credits………………………………………..…….….6
2.2. - Insurance instruments……………………………………………………………….….…6
2.3. - Instruments issued by governments and government-related institutions……….…7
3. - Reasons for the recent trade finance shortages………………………………………….7
3.1 - Failure in the trade finance market………………………………………………………7
3.2. - Cost of implementation of the Basel II and Basel III frameworks…………………..8
4. - Causes for trade collapses: the compositional effect, trade finance and vertical
fragmentation…………………………………………………………………….…………..……8
4.1. - Presumptive absence of impact from national protectionist…….…………………...8
4.2. - Circumstances identified as drivers of trade collapses……………………………….9
4.2.1. - The Compositional effect…………………………………………………………….…9
4.2.2. - Trade finance shortages……………………………………………………………..….9
4.2.3. - Worldwide vertical fragmentation of production ………………………………….10
5. - The hypothesis of the impact of trade finance shortages on trade collapses…...…..10
5.1. - The hypothesis of the impact of trade finance shortages on trade collapses……..12
5.1.1 - Research focused on developed economies…………………………………….……12
5.1.2. - Research focused on emerging and developing economies……………………....13
5.3. - Criticisms to the hypothesis of the impact of trade finance on trade………..…….14
6. - The impact attributable to credit shortages in the availability of trade finance:
Evidence from the IMF and the BAFT…………………………………………………….….14
7. - Policy reactions and remaining challenges……………………………………...……..16
V. SUMMARY OF THE LITERATURE REVIEW, CONCLUSIONS AND
RESEARCH GAPS………………………………………………………………...…..18
VI. RECOMMENDATIONS FOR FUTURE RESEARCH……………………...……19
REFERENCES…………………………………………………………………………20

3. 2
I. ABSTRACT
According to the World Trade Organization, trade finance provides sustain to
nearly 90% of the world’s trade. Threatening this crucial function, the ongoing
financial crisis has raised a number of obstacles to the supply of international trade
finance, marked by a significant contraction in trade credit. This shortage in the offer of
trade finance instruments, together with a prominent decrease in the consumption of
imported goods stemmed from the economic recession, has eventually led to the so-
called “Great Trade Collapse” affecting transnational trade flows since mid-2008 until
early in 2009. As many authors and international organizations have noticed,
international trade flows have collapsed at a faster rate than that of the world’s GDP
during the period at hand, yielding the most conspicuous trade contraction the
humanity has suffered since the irruption of the Great Depression in 1930.
This research paper aims to discuss to what extent international trade finance plays
a crucial role in the preservation of the current financial and trade systems, highly
globalized and interdependent. Bearing this purpose in mind and using the last trade
collapse as illustration, we will study the different reasons undermining the mechanism
upon which trade rely, the relative weight attributable to international trade finance
and the reasons underlying shortages in the supply of trade finance instruments during
periods of financial instability. To conclude, the most relevant policy proposals destined
to the mitigation of trade finance shortages will be exposed as an illustration of means
to avoid similar phenomena in the future.

4. 3
II. INTRODUCTION AND BACKGROUND
According to the World Trade Organization1
, around 90% of the world trade flows
are sustained through trade finance, frequently under the form of credit or guarantee,
and related services, such as counterparty default risk assessment, payment guarantee to
the exporter or insurance against exchange rate risk, which have become crucial for the
smooth and predictable functioning of the trade system.
The current financial crisis has raised a number of obstacles for the supply of trade
finance instruments, marking a significant contraction on the offer of trade credit that
definitely undermined the foundations of the whole international trade system. Many
economists (e.g. Davin Chor and Kalina Manova2
), defend that two circumstances
stemming from the 2008 global financial crisis underlie the collapse of trade flows: on
the exporter side, the scarcity of trade credit during the peak of the crisis limited the
financial soundness of export-import operations; on the consumer side, the adverse
economic forecast, high unemployment rates and deficiency of credit available for the
finance of consumption and investment dropped the demand of imported durable and
non-durable goods. Hence, the shortage of trade credit combined with the shrink in the
demand for imported goods has eventually led to the so-called “Great Trade Collapse”
(2008-2009), affecting world trade flows since mid-2008 in a magnitude that is
estimated around 30% relative to the world’s GDP3
and dropping at a faster rate than
this latter magnitude or in any other period in history since the 1930’s Great Depression
(obviously excluding the World War II).
This decline in international trade flows has spread worldwide its pernicious effects
in combination with the phenomena of vertical fragmentation of global value chains,
given that the process of globalization has been stimulating during the last two decades
the interconnection among countries through the trade of intermediate goods that
nourish trans-national production lines and supply chains. This combination of
circumstances has provoked a chain reaction that eventually has contributed to the
spread of recessionary trends worldwide, even to countries with a low degree of
exposure to the U.S.’ subprime market.
Numerous governments, public-baked institutions and international organizations,
including the World Trade Organization (WTO) and the International Monetary Fund
(IMF) assisted by the G-20, have reacted with limited success to this shortage through
trade policies aimed to cover the demand of trade finance that private institutions have
failed to supply. According to the WTO, this gap in supply in the trade finance market
1
WORLD TRADE ORGANIZATION, “Trade Finance: The Challenges of Trade Financing”.
2
CHOR D., and MANOVA K., “Off The Cliff and Back? Credit Conditions and International Trade
During The Global Financial Crisis”. Journal of International Economics, Issue 87, 2012, pp. 117.
3
EATON J., KORTUM S., NEIMAN B., and ROMALIS J., “Trade and The Global Recession”. National
Bureau of Economic Research, NBER Working Paper Series, Working Paper 16666, Cambridge,
December 2009, pp. 1.

5. 4
can be estimated between $200 and $300 billion, encouraging the raise of issuing prices
of financial instruments4
.
III. RESEARCH PROBLEM, OBJECTIVES AND QUESTIONS
This research paper reviews the existing academic and official literature on the
impact of trade finance instruments shortages on the volume of trade flows and more
specifically focusing in the experience learned from the “Great Trade Collapse” (2008-
2009). The following main questions will be developed during this work:
- First, the role of trade finance as a mean to reduce uncertainty and extra costs
related to cross-border transactions will be analyzed. The main instruments currently in
use for this objective will be briefly exposed. To conclude this section the reasons
identified by the World Trade Organization as triggers of the trade finance shortage will
be explained.
- Secondly, the reasons underlying the recent trade collapse will be identified. As
we will see later, not only international trade finance, but also the composition of the
demand for imported goods, the globalization of value chains and, potentially,
protectionist measures have contributed to the irruption and spread of the trade collapse.
- Third, arguments in favor and against the hypothesis of the impact of trade
finance instruments shortage on the volume of international trade will be provided,
based in the findings of research papers carried out by the academia and devoted to the
analysis of such correlation.
- Fourth, with the aim of obtaining a more accurate picture, we will analyze
evidence provided by the International Monetary Fund regarding the perception the
impact of trade finance.
- Last, the trade policies implemented at the international level will be explained, as
well as the main lessons we can draw from the management of the trade collapse.
4
AUBOIN M. and ENGEMANN M., “Trade Finance in Periods of Crisis: What Have We Learned in
Recent Years?”. World Trade Organization, Economic Research and Statistics Division, January 2013,
pp. 1-29

6. 5
IV. EMPIRICAL LITERATURE REVIEW
1. - The role of trade finance
Companies involved in international trade frequently rely on external capital to
support expenditures related to export operations. Fixed costs related to export are, for
instance, researching the profitability of untapped markets, adapting the product to the
needs and regulations of the export market, or to maintain international distribution
channels, whereas variable costs comprise freight, insurance, duties and clearances for
each unit or bundle of goods exported.
International trade often requires, by nature, longer delivery times than intra-
domestic transactions and hence increases working capital needs. As a matter of fact,
carriage of goods by sea, which accounts for the transportation of roughly 90% of world
trade by weight5
, may imply transit periods of several weeks and hence accounts
receivable will be issued in favor of foreign purchasers whenever COD (i.e. cash on
delivery) is the chosen term of payment. These cross-border transactions entail, inter
alia, two major risks: default risk, or the probability of the foreign purchaser refusing
the reception of the goods sold under the pretext of a breach in the sales contract, and
exchange rate risk, or the exposure to adverse fluctuation in the exchange rate of the
currency of payment.
Private financial operators, governments and certain international organizations are
committed to meet the needs derived from export activities through the supply of trade
finance instruments. As we have alluded above, the World Trade Organization estimates
that these instruments provide coverture to around 90% of the world trade flows. The
economists Silvio Contessi and Francesca de Nicola noticed6
that the supply of trade
finance instruments responds to two main purposes: on the one hand, they provide an
injection of working capital (i.e. current assets minus current non-financial liabilities
under the IFRS) to companies requiring liquid assets; on the other hand, they provide
credit insurance against default risk, exchange rate risk, and political risk (i.e. not only
the probability of political instability but also of imposition of trade restrictions such as
embargoes, quotas and additional tariffs during the transit of the goods).
In conclusion, international trade is more vulnerable than domestic trade due to
risks derived from counterparty and exchange rate risks and thus trade credit and other
insurance instruments are crucial. Problems arise, though, when is the financial
institution providing credit finance itself lacks of the required solvency to be considered
as trustworthy, which undermines a system aimed to the mitigation of risk. Under such
circumstances, national export-import banks must cover the deficiency of trade credit,
5
DAVID P., and STEWART R., “International Logistics: The Management of International Trade
Operations”. Cengage Learning, Third Edition, 2010, pp. 262.
6
CONTESSI S., and DE NICOLA F., “The Role of Financing International Trade During Good Times
and Bad”. The Regional Economist, January 2012, pp. 6.

7. 6
yet the recent trade collapse demonstrate that, despite their intensive commitment, this
movement reached the market late7
.
2. - Brief reference to the main trade finance instruments in use
Trade finance comprises a number of instruments aimed to well different ends. We
will distinguish between instruments providing credit to trade, those aimed at the
coverage against certain trade-related risks and those offered by governments and public
agencies to facilitate trade flows.
2.1. - Documentary credits and trade credits
The primary distinction can be drawn between documentary credit and generic
trade credit, as proposed by Contessi and de Nicola8
: On the one side, documentary
credit in the form of letters of credit issued by commercial banks is the paramount
instrument for financing international trade. Under this instrument the issuing institution
assumes the undertaking as to pay the exporter a certain pecuniary sum on behalf of the
importer provided that the terms and conditions of the sale contract have been duly
observed. The use of letters of credit allows the importer to allocate generated cash
flows to other productive activities and ensures the payment to the exporter in due time.
Thus, documentary credits are employed to mitigate risk when the creditworthiness of
one of the parties cannot be reliably assessed, as contract enforcement between banks is
easier than between trading partners. On the other side, generic trade credit is the
traditional instrument in use (i.e. short-term credit covers around 80% of the trade credit
according to market surveys9
), consisting in the exporter agreement to sell the goods on
account and thus allow the foreign purchaser to pay at a certain date, commonly 30, 60
or 90 days after the delivery. When this occurs, the credit is recorded as an account
receivable in the exporter’s statement of financial position (i.e. balance sheet), and
hence the company itself is financing the acquisition by its foreign customer.
2.2. - Insurance instruments
Different end pursue the so-called insurance instruments, aimed to the mitigation of
the specific risks that international trade entails: Firstly, some instruments bear the
function of covering the exporter or the importer against gains or loses derived from
fluctuations on the exchange rate of the currency of payment. Options, forwards,
futures, swaps and spot contracts fall into this category. Secondly, as a widely used
alternative to the letter of credit we find the bill avalization, by which commercial banks
guarantee the payment to the exporter against the realization of default risk, that is to
say the breach by the foreign purchaser of its undertaking as to pay the goods ordered.
7
MCKINNON R.I., et al., “Collapse in World Trade: a Symposium of views”. The Magazine of
International Economic Policy, Washington D.C. Spring 2009, pp. 30.
8
CONTESSI S., and DE NICOLA F., “The Role of Financing International Trade During Good Times
and Bad”. The Regional Economist, January 2012, pp. 7.
9
WORLD TRADE ORGANISATION, “Trade Finance and the WTO”. WTO E-Learning, March 2013,
pp. 2.

8. 7
Lastly, as another mean to avoid the risk of default linked to the concession of trade
credit we find the contract of forfeiting. When this contract is signed, the exporter
transmits the debt from a sale on account to a third party, often a financial institution,
who will advance the exporter a sum of money equal to the value of the debt minus a
discount. Through this contract the exporter transmits to the third party the risk of
default related to the transaction in exchange of a discount fee.
2.3. - Instruments issued by governments and government-related institutions
Firstly, export credit insurance agencies can be found amongst the institutions
involved in the financing of international trade. These institutions intermediate between
national government and companies involved in international trade, with the aim of
providing financial services, whether in the short (i.e. up to 180 days) or long (i.e. up to
3 years) term, meeting the need of credit to cover production and transportation costs, as
well as insurance services protecting against a range of risks, from exchange rate
fluctuations to political instability10
. Secondly, many central banks offer what is known
as refinancing schemes, similar to the forfeiting mechanism above explained, whereby
commercial bills from international trade transactions are discounted at preferential
rates. Lastly, specialized financial agencies, commonly under the denomination of
“Export-Import Banks” or abbreviated “Exim Banks” (e.g. the Export-Import Bank of
the United States, Export-Import Bank of China, Exim Bank of South Africa, and so
forth), are devoted to the emission of instruments that cover the financing needs of
companies involved in international trade.
3. - Reasons for the recent trade finance shortages
According to Marc Auboin and Nadia Rocha, both economists at the Economic
Research and Statistic Division of the World Trade Organization, two would be the
major reasons for shortages in the supply of trade finance instruments, namely potential
market failures and cost of implementation of the Basel II rules.11
3.1 - Failure in the trade finance market
Misinterpretations of commercial risks, always accompanying financial crises, are
likely to trigger a phenomenon of “herd behavior” amongst private financial operators.
This perception of commercial risk is correlated to the uncertainty provoked by changes
in the creditworthiness of banks, country risk, prolonged exchange rates fluctuations,
lack of transparency and adverse signals sent by credit rating agencies. In such cases,
trade finance suppliers are reluctant to provide credit to banks showing signs of an
unsound financial situation or to suffer excessive risk exposure by operating directly
and under their own account in secondary markets, which has led, together with an
10
CONTESSI S., and DE NICOLA F., “The Role of Financing International Trade During Good Times
and Bad”. The Regional Economist, January 2012, pp. 8.
11
AUBOIN M. and ROCHA N., “Trade Finance: The Grease in The Wheels of Trade”. World Trade
Organization, Economic Research and Statistic Division, March 2009, pp. 1-7.

9. 8
aggravated insufficiency of liquidity in monetary markets and the reassessment of
customer and country risks, to an escalate in prices and limited supply of trade finance
instruments.
The fact that the current financial crisis has led to more restrictive credit conditions
along with a declining availability and increasing prices seems to be generally accepted
amongst economists. Nevertheless, the impact of these worsened conditions in the
access to trade finance instruments on the volume of trade flows remains difficult to
assess given the scarcity of data, with no comprehensive statistics available, and the
subjective component underlying lending decisions.
3.2. - Cost of implementation of the Basel II and Basel III frameworks
The strict capital requirements enforced by the Basel II and III frameworks have
difficult the access to trade credit during the ongoing financial crisis. This negative
impact is especially intense in the case of developing countries, since these regulations
require larger amounts of capital for activities bearing higher risk of default, typical
operations taking place in these countries. The implementation of risk weights and the
confusion between counterparty and country risks enforced in the Basel II rules have
raised frictions for institutions willing to finance transactions involving parties in
developing countries. Additionally, the Basel III rules impose the requirement of a
100% leverage ratio for letters of credit not reflected in balance sheet (extensively used
in commercial operations in developing countries)12
. This has encouraged risk adverse
trade credit suppliers to revise their exposure to such regulatory requirements and
deviate finance flows to other safer projects for the sake of profitability.
4. - Causes for trade collapses: the compositional effect, trade finance and vertical
fragmentation
Hoda El-Ghazaly and Silvio Contessi propose an interesting identification of the
causes underlying the “Great Trade Collapse”13
, trying to respond to the fact that
despite trade finance has been proven a trigger of the trade collapse, its relative impact
compared to other culprits still causes dissention. As we will see, not only deficits of
trade finance, but also the interdependency of countries in terms of production and
demand provoked a chain reaction with fatal consequences for international trade.
4.1. - Presumptive absence of impact from national protectionist
Contrarily to the general assumption of trade protectionist measures raised by
governments during recessionary periods, El-Ghazaly and Contessi defend that such
12
AUBOIN M. and ENGEMANN M., “Trade Finance in Periods of Crisis: What Have We Learned in
Recent Years?”. World Trade Organization, Economic Research and Statistics Division, January 2013,
pp. 1-29
13
EL-GHAZALY H. and CONTESSI S., “The Trade Collapse: Lining Up the Suspects”. The Federal
Reserve Bank of St. Louis, The Regional Economist, Vol. 18, No. 2, April 2010, pp. 10-11.

10. 9
measures virtually have not been implemented during the last trade collapse. The reason
for this argument is that the World Trade Organization prohibits, controls and sanctions
the application of any form of quantitative measures14
and restricts the application of
tariffs in a discriminatory manner15
. Others, for instance Richard Baldwin and Simon
Evenett16
, have identified an increase in protectionist measures in certain countries in an
attempt to react to the crisis, yet have not found a remarkable impact of these measures
on the collapse of trade.
4.2. - Circumstances identified as drivers of trade collapses
Reductions on trade flows have been traditionally attributed to shrinking internal
demand of imported final goods. Nonetheless, other additional reasons such as trade
finance and vertical fragmentation of trade deserve equal attention.
4.2.1. - The Compositional effect
The impact of decreases in demand of goods on international trade can be amplified
when the degree of involvement in international trade is unequally distributed amongst
industries. When consumers readjust their spending, the composition of the decrease in
demand may affect in a more intense magnitude the decline in trade than the decline in
GDP for the mere reason that the most affected industries may account for the biggest
share of trade. This explains why during the last US recession the industries suffering
the largest downturn in output accounted for the largest proportion of trade decline (e.g.
industrial supplies, computers, automotive vehicles, engines and so forth).
4.2.2. - Trade finance shortages
Trade finance ensures the soundness of the bulk of international trade flows and
hence the deficit of trade credit has been one of the main contributions to the decrease
in the number of transactions. Exporting companies count with lesser incentives to get
involved in cross-border operations when the access to finance becomes limited or
unaffordable, as has been proved by Tim Schmidt-Eisenlohr17
, who proved through data
on bilateral trade volumes that trading partners undertake a more reduced number of
transactions when trade finance costs are higher and also in negative correlation to the
distance between the import and export countries as this increases the lapse between
delivery and payment. It can also been observed that industries with a stronger
dependence on external financing have suffered more intensely the scarcity of credit.
14
Article XI.1 of the GATT 1947: “No prohibitions or restrictions other than duties, taxes or other
charges, whether made effective through quotas, import or export licenses or other measures, shall be
instituted or maintained by any contracting party on the importation of any product […]”.
15
Article III.1 of the GATT 1947: “[…] internal taxes and other internal charges […] should not be
applied to imported or domestic products so as to afford protection to domestic production”; and Article
16
BALDWIN R. and EVENETT S., “The Collapse of Global Trade, Murky Protectionism, and the Crisis:
Recommendations for the G-20”. The Graduate Institute of Geneva, Centre for Trade and Economic
Integration, 2009.
17
SCHMIDT-EISENLOHR T., “Towards a Theory of Trade Finance”. University of Oxford, January
2012.

11. 10
4.2.3. - Worldwide vertical fragmentation of production
Vertical fragmentation has been propagating during the last two decades alongside
with the process of globalization. International shippers have developed economies of
scale, based on the increasing volume of international trade flows that eventually have
resulted in lower transport costs. Under this new cost structure, vertical fragmentation
has spread value chains worldwide, and hence each step in the production process, from
the source of raw material to the retail of finished goods to final customers, entail the
performance of cross-border trade operations.
Nowadays the largest share of international trade from and into industrialized
countries is conformed of flows of productive assets and intermediate goods rather than
final goods. As the authors note, in the case of the United States the relevance of
vertical fragmentation is such that intermediate goods account for about three fourths of
the total inbound and outbound, which can be understood if we consider, for instance,
that the country is the biggest consumer of technological devices in the world (i.e.
goods which are manufactured along supply chains with production stages deployed
over different countries).
In definitive, under this globalized production scheme a drop in the demand of final
goods is likely to spark off a chain reaction with fatal consequences for the demand of
intermediate goods downstream the value chain, and thus spread the effects of an
economic slowdown to other countries in a more than proportional pattern. There is
evidence pointing that the effects of the “Great Trade Collapse” have been more severe
on industries making intensive use of intermediate goods. Even though not commented
by the authors, it worth’s pointing out at the crucial role that trade finance plays
throughout these globalized value chains, making feasible and sound the transmission of
goods as they move downstream this globalized system upon which depends the bulk of
the world’s economic activity.
5. - The hypothesis of the impact of trade finance shortages on trade collapses
International trade shrunk by approximately 30% in relation to the world GDP
between mid-2008 and early 2009. According to a research paper published by Jonathan
Eaton, Samuel Kortum, Brent Neiman and John Romalis18
, the bulk of this decrease is
associated with a loss in weight of tradables over the total cross-border demand in favor
of durable manufactures, accounting the latter for some 65% of the decrease in
manufactures trade. The combined effect of durable and non-durable goods is estimated
to account for 80% of the decrease in international trade during the “Great Trade
Collapse”.
18
EATON J., KORTUM S., NEIMAN B., and ROMALIS J., “Trade and The Global Recession”.
National Bureau of Economic Research, NBER Working Paper Series, Working Paper 16666,
Cambridge, December 2009, pp. 3.

12. 11
The remaining 20% decrease in trade (or nearly 27% according to a survey carried
out jointly by the IMF and the BAFT –see below in this paper–) would be explained, as
many economists agree19
, by trade credit constraints as banking systems around the
world emit signs of unsound financial situation and dispel global suppliers of trade
finance from providing the demand of trade financing instruments. This eventually
limited the accessibility of export companies to external finance, aggravating more
intensely companies operating in sectors highly dependent on external capital.
Source: ASMUNDSON et al., “Trade Finance in the 2008-09 Financial Crisis”. International Monetary
Fund, Working Papers, January 2011.
As we can observe in the graphic above, the contraction of trade flows during the
peak of the “Great Trade Collapse” can be partially explained by the contraction of
trade finance markets. This section is devoted to contrast evidence gathered by
researchers in the U.S and Europe, both in favor and against the relevance of trade
finance on the number of firms involved in international trade and the volume of trade
flows. For the sake of intelligibility I will not reproduce the econometric models built
and employed by the below-mentioned authors but rather distill the essence of their
findings.
19
e.g. BRICONGNE J.C., FONTAGNE L., GAULIER G., TAGLIONI D., and VICARD V., “Firms and
The Global Crisis: The French Exports in The Turmoil”. European Central Bank, Working Paper Series,
No.1245, September 2010.

13. 12
5.1. - The hypothesis of the impact of trade finance shortages on trade collapses
The availability of trade finance instruments defines the likelihood of the
involvement of companies in international trade operations. These may need external
finance to cover, on the one side, fixed costs related to the start-up of export activities,
while on the other side, marginal costs related to the export of each additional unit.
Hence, from a logical standpoint it seems evident that the degree of accessibility to
international trade finance exerts an influence over the number of exporters (i.e.
extensive margin) and the magnitude of goods exported (i.e. intensive margin)20
.
5.1.1 - Research focused on developed economies
Kalina Manova provides evidence in favor of the impact of accessibility to trade
finance on the volume of trade flows on the grounds of two facts: dependence on
external finance varies across industries and the cost and availability of external finance
vary across countries21
. By analyzing the impact of equity markets liberalization cases
occurred during the last decades in certain nations, the author proves that such processes
boosted the volume of trade flows in a remarkable higher degree when it came to
industries more dependent on external finance and to economies formerly counting with
less active financial markets and higher costs due to restrictive trade policies.
Another research, carried out by Kalina Manova jointly with Davin Chor, is
devoted to demonstrate that worsening credit conditions were the mean whereby the
financial crisis of 2008 affected trade flows and subsequently led to the Great Trade
Collapse22
. Countries maintaining higher interbank interest rates, hence counting with
limited access to credit, generated lower amounts of inbound trade flows to the U.S.
during the peak of the crisis. Consequently, industries highly dependent on external
finance showed more marked decreases on exports, as these were more responsive to
the cost of external capital than those from sectors less dependent on credit. In
definitive, interventionism through policies aimed to reduce the cost of external capital
(e.g. altering interbank interest rates), potentially increase the accessibility of exporters
to credit and therefore generate gains on the volume of trade flows.
Crossing the Atlantic, it is possible to broaden our point of view through numerous
research papers not limited to U.S.-focused data. For instance, Jean-Charles Bricongne,
Lionel Fontagné et al., carried out a research focused on the effect of credit constraints
on French exporting companies23
. According to their findings the overall impact of
20
CONTESSI S., and DE NICOLA F., “The Role of Financing International Trade During Good Times
and Bad”. The Regional Economist, January 2012, pp. 8.
21
MANOVA K., “Credit Constrains, Equity Market Liberalizations and International Trade. Journal of
International Economics, Issue 76, 2008, pp. 33-47.
22
CHOR D., and MANOVA K., “Off The Cliff and Back? Credit Conditions and International Trade
During The Global Financial Crisis”. Journal of International Economics, Issue 87, 2012, pp. 117-133.
23
BRICONGNE J.C., FONTAGNE L., GAULIER G., TAGLIONI D., and VICARD V., “Firms and The
Global Crisis: The French Exports in The Turmoil”. European Central Bank, Working Paper Series,
No.1245, September 2010.

14. 13
trade credit constraints remained limited in the case of France, given that the weight of
exporting companies highly dependent on external finance instruments was modest
compared to the whole spectrum of French companies involved in international trade.
The authors remark that in the case of France, which is similar to the majority of
developed countries, international trade is virtually limited to a small number of big
multinational companies, while a large number of small competitors can afford to
undertake cross-border trade operations on an irregular basis. As a matter of fact, in
France the top 1% of companies involved in international trade account for 63% of the
total national exports, whereas the 80% of low tier companies amount merely 3% of the
total outbound trade. Nevertheless, the authors proved that the above-mentioned
reduction by 20% on trade flows would have been driven by credit constraints affecting
industries highly dependent on trade finance instruments.
Amiti and Weinstein24
provide an example from the Pacific. These authors proved
that in the case of financial crises affecting the Japanese economy during the 1990s the
contraction of external trade was partially instigated by scarcity on the supply of trade
finance, caused by the unsound health of the Japanese banking system, which accounted
for nearly one third of the exports drop. These authors, hence, demonstrated causality
between the health of the banking system and the volume of exports, which became
more intense for those companies contracting with financially unsound banks.
Industries highly dependent on international trade finance would be, according to
various studies mentioned by Contessi and de Nicola25
, the pharmaceutical, plastics
manufacturing and computer electronics industries. Contrarily, other industries show a
limited dependency, as is the case of tobacco and pottery industries.
5.1.2. - Research focused on emerging and developing economies
Focusing on data published by the World Bank comprising more than 5,000
exporting companies in 9 developing and emerging economies, Nicolas Berman and
Jérôme Héricourt analyzed the effects of financial conditions on the intensity of export
activities in such countries26
. Their findings point that the coverture of initial fixed and
sunk costs required to access foreign markets are the key determinant for the likelihood
of a company to perform export operations, and thus the degree of accessibility to trade
finance focuses its influence on the initial decision of whether or not to serve markets
abroad. Little impact bears, nevertheless, the financial situation of an exporting
company on the decision of continuing operations once the entry decision has been
made, given that any subsequent fixed cost required is considerably lower than the
24
AMITI M., and WEINSTEIN D., “Exports and Financial Shocks”. National Bureau of Economic
Research, NBER Working Paper Series, Cambridge, December 2009, pp. 2.
25
CONTESSI S., and DE NICOLA F., “The Role of Financing International Trade During Good Times
and Bad”. The Regional Economist, January 2012, pp. 9.
26
BERMAN N., and HERICOURT J., “Financial Factors and the Margins of Trade: Evidence from
Cross-Country Firm-Level Data”. Centre National de la Recherche Scientifique, Documents de Travail du
Centre d’Economie de la Sorbonne, Paris, 2008.

15. 14
initial costs. The authors also proved that financial development impacts positively the
likelihood of undertaking exporting activities, since the more financially developed is
an economy the more productive will its local companies be and therefore the more
these will export.
5.3. - Criticisms to the hypothesis of the impact of trade finance on trade collapses
Against the hypothesis of the role of trade finance, we can mention Andrei A.
Levchenko, Logan T. Lewis and Linda L. Tesar27
. These authors analyzed the
econometrical correlation between the availability of financing instruments and
variations on international trade through the contrast of data relative to imports and
exports in U.S.’ industries characterized by an intensive use of trade credit. Whereas
there is evidence that trade flows dropped more severely in the case of sectors
depending more intensively on trade finance, the authors did not find clear evidence of
more pronounced impacts on trade flows from countries suffering stronger credit
contractions and state that even though cross-sector differences can be admitted the
average impact would be nullified. Therefore, the authors conclude that the 2008 trade
collapse would be explained by the compositional effect and vertical specialization,
both analyzed above, assuming that the impact on trade derived exclusively from a
decrease on economic activity.
6. - The impact attributable to credit shortages in the availability of trade finance:
Evidence from the IMF and the BAFT
A survey carried out by the International Monetary Fund (IMF) and the Bankers’
Association for Trade Finance (BAFT) in March 2009 and targeting 44 relevant banks
from 23 countries, sheds light on the impact of worsening credit conditions on the
availability of trade finance28
.
This survey reveals that, in line with the situation in credit markets, the value of
issued trade finance instruments decreased between October 2008 and January 2009
compared to the previous year-to-date, leaded by a pronounced decline of letters of
credit. As we can see in the graphics below, the utmost decline has been caused by a
dramatic drop in the value of letters of credit, by an average of 11% during the analyzed
period, as 71% of the surveyed banks pointed to a decline in the value of this
instrument. In contrast, instruments under the form of export credit insurance and short-
term export working capital caused little impact, with average declines of 4% and 3%
respectively.
27
LEVCHENKO A., LEWIS L., and TESAR L., “ The Collapse of International Trade During the 2008-
2009 Crisis: In Search of The Smoking Gun”. National Bureau of Economic Research, NBER Working
Paper Series, Working Paper 16006, Cambridge, May 2010, pp. 17-19.
28
INTERNATIONAL MONETARY FUND and BANKER’S ASSOCIATION FOR TRADE FINANCE,
“IMF-BAFT Trade Finance Survey: A survey Among Banks Assessing the Current Trade Finance
Environment”. FI metrix, March 2009.

16. 15
Source: “IMF-BAFT Trade Finance Survey: A survey Among Banks Assessing the Current Trade
Finance Environment”, pp.3.
Virtually all the world’s regions have experienced declines in the value of the
issued trade finance instrument, yet differences in terms of intensity can be drawn:
Eastern Europe experienced the highest average decline during the period, 13%,
whereas Middle East and Magreb suffered a much limited 5% decrease. When it comes
to industrialized countries as a whole, 9% is the decline suffered in average between
October 2008 and January 2009.
According to the surveyed institutions, the shrink in demand for imported goods
would explain around 73% of the decrease in aggregated value of the offer of finance
instruments, while the remaining 27% would be attributable to the scarce credit
availability. When asked about the reasons for the decline in value of trade transactions,
around 57% of these banks pointed at limited credit availability, both at their own
institutions and at counterparty banks, 73% to the shrinking demand, and 11% to the
economic slowdown or increased global risk.
Last but not least, the survey exposes an increasing trend on the price of trade
finance instruments, which would support the WTO economists Auboin and Rocha’s
first thesis of failures in trade finance markets. The graphic below reflects that the
ongoing financial crisis has, indeed, negatively affected the evolution of pricing
conditions between 2008 and 2009: export credit insurance has doubled in price,
followed by documentary credit as the second most affected group, while short and
medium-term lending were issued at slightly lowered prices. Despite the price increase,
only letters of credit experienced a remarkable reduction in issued value, as we have
formerly discussed, while export credit insurance remains virtually unaffected during

17. 16
the analyzed period. The latter may probably stem from the increased perception of risk
that has characterized the 2008 financial crisis.
Source: “IMF-BAFT Trade Finance Survey: A survey Among Banks Assessing the Current Trade
Finance Environment”, pp.8.
Confirming Auboin and Rocha’s second thesis on the cost of implementation of the
Basel II and Basel III rules, increased capital requirements have, as 58% of the
respondents admit, impacted the price evolution between October 2008 and January
2009. Whether the implementation of the rules has undermined or improved the banking
system’s ability to provide trade finance remains discussed: 33% of the institutions
believe these rules exert a negative impact due to greater restrictions and cost of capital,
while 27% state that these encourage a more selective offer of trade finance through the
obligation of undertaking a more diligent and individualized risk analysis. As it has
been also noticed by Auboin and Rocha, the survey demonstrates that the Basel II Rules
have hardened the access to trade finance in developing countries as 83% of the banks
claim the establishment of more cautious guidelines in the offer of instruments to
certain countries and 60% perceived an increase in the probability of defaults, which
point to country-related and default risks avoidance.
7. - Policy reactions and remaining challenges29
In response to the “Great Trade Collapse”, public and private institutions have
undertaken different measures with the aim of mitigating the impact of the current
financial crisis on the ability to offer trade finance instruments and of covering the gap
between its supply and demand (which, as we know, is estimated between $200 and
29
Based on AUBOIN M. and ENGEMANN M., “Trade Finance in Periods of Crisis: What Have We
Learned in Recent Years?”. World Trade Organization, Economic Research and Statistics Division,
January 2013, pp. 1-29

18. 17
$300 billion and related to the liquidity deficiency in monetary markets). Most of the
improvements in this field have been encouraged by the partnership between the
International Monetary Fund (IMF) and the World Trade Organization (WTO) as their
work is complementary given that a sound financial system is needed to ensure the
consistent flow international trade while this latter contributes to reduce the risk of
payment imbalances and financial crisis.
A major issue during the trade collapse was the absence of comprehensive
international trade finance statistics, pointing to difficulties of the statistical system to
record short-term capital flows which, as we have previously noticed, account for 80%
of trade credit. As a consequence balance of payments and trans-national banking
statistics have been seriously undermined. The WTO has reacted to this drawback by
promoting the construction of survey-based data sourced from professionals in the field
of trade finance, yet this measure, even being practical in a period requiring quick
responsiveness, cannot provide the level of detail required for sound decision-making
and that comprehensive statistics can provide. Consequently, the WTO, the IMF, the
BAFT, the ICC and the SWIFT are working together to consolidate the gathered data in
a single publication which is intended to yield a sound statistic database in the future.
The main advancement, nonetheless, concerns the gathering of all the stakeholders
when designing and implementing measures to avoid trade finance gaps affecting global
and regional trade flows: on the one side, a contact group is formed of export credit
agencies, banks, multilateral and development agencies; on the other hand the WTO and
the World Bank have worked together to ensure the support of the G-20. This has
resulted in a trade finance initiative, designed at the G-20 summit in London (2009),
aimed at flexibly identify any stakeholder affected along the trade credit supply chain
and respond to its needs with the ultimate goal of mitigating risk that can be eventually
misinterpreted and lead to market failures. To provide those needs, the G-20 approved a
trade finance package ensuring the availability of a $250 billion pool to support trade
finance in a 2-year period and providing guarantee instruments that can be supplied by
export credit and multilateral agencies to cover political and commercial risks, which
has proved to be effective and responsive in recovering balance in trade finance
markets. Additionally, a working group has been established with the aim of monitoring
the implementation of the London trade finance initiative through data on commitment
and utilization rates (i.e. through this data we can observe that the average utilization
reduced to 40% in the second half of 2009 compared to 68% in the first half of 2009,
pointing at the progressive recovery of trade finance markets).
Despite the relative success of the measures implemented at the G-20 level, the
structural financial drawbacks affecting developing countries, namely amongst others
the gap between perceived and actual risk and the stringent requirements enforced under
the Basel II and III frameworks, remain unaddressed in line with the absence of long-
term public commitment and scarce support to multilateral development institutions.

19. 18
V. SUMMARY OF THE LITERATURE REVIEW, CONCLUSIONS AND
RESEARCH GAPS
The recent financial crisis has severely impacted the volume of international trade
flows through, inter alia, the channel of trade finance markets. Other mechanisms
contributing to the spread and intensification of the “Great Trade Collapse” are
identified by the academia as the compositional effect of demand of imported goods, the
vertical fragmentation of value chains fueled by the process of economic globalization,
and protectionist measures that arise overlooking the WTO agreements, yet the latter
remaining discussed.
Empirical evidence collected and analyzed with occasion of the “Great Trade
Collapse” supports the hypothesis of the impact of accessibility to international trade
instruments on the number of exporters (extensive margin) and the magnitude of
international trade flows (intensive margin), which intensifies in the case of industries
highly dependent on external financial sources. From the side of the offer of trade
finance instruments, financial institutions have faced a more difficult scenario driven by
a deficit of liquidity, the misinterpretation of risk, whereas from the side of the demand
of such instruments, exporters are discouraged by higher prices and a more selective
criteria applied for the concession of credit. Moreover, the conditions imposed by the
Basel II and Basel III frameworks raise further barriers to the access to trade finance,
especially when partners from developing countries are involved as higher capital
requirements are requested along with increasing risk.
More discussed is the relative weight of trade finance on the decline in trade flows
occurred during the 2008-2009 period. Generally speaking, most of the economists
agree that, despite the biggest bulk (between 70 and 80%) should be accounted to the
shrinking demand of imported goods, a considerable share of such decrease can be
allocated to frictions in the offer of trade finance (between 20 and 30%). The
conclusions reached by the different authors mentioned can be summarized as follows:
- Improvements in the availability of trade finance instruments are likely to increase
the volume of trade flows, especially when it comes to industries highly dependent on
external finance (Manova, 2008).
- Higher interbank interest rates and in general worse conditions to obtain access to
trade finance are likely to negatively impact the volume of trade flows, especially
within sectors more responsive to the cost of trade finance. Policies aimed at relaxing
such stringent conditions potentially stimulate trade flows (Manova and Chor, 2012).
- Concentration of trading capacity in the hands of a few top tier competitors (i.e.
multinationals), as it is common in most developed countries, reduces the dependency
on trade finance and thus the impact of worsening conditions (Bricongne et al., 2010).
- In the case of developing countries, the accessibility to trade finance is crucial for
the initial decision of setting up export operations, as higher fixed and sunk costs must
be undertaken to access a new market, whereas once a company has already started
cross-border operations its financial situation bears little impact as additional fixed costs

20. 19
are considerably lower. Furthermore, financial development impacts positively the
volume of trade flows through increased productivity (Berman and Héricourt, 2008).
- Against the hypothesis of this impact, some authors have argued that no evidence
of correlation between stronger credit contractions and variations of international trade
can be drawn, as the average impact would be nullified and the causality would be more
clearly explained by the compositional effect (Levchenko et al. 2009).
Some authors, therefore, have challenged the hypothesis of the impact of trade
finance shortages on the decline international trade. With this aim econometric models
have been used to prove the absence of correlation between both phenomena. Leaving
aside potential drawbacks of such analysis (i.e. absence of a reliable statistical database
on trade finance), the most comprehensive information up to date, that is to say the data
released by the IMF, the WTO and the BAFT, shows that up to 27% of the trade
collapse has been potentially caused by the shortage of trade finance. Regardless the
higher weight of the impact stemmed from demand composition, the share attributable
to trade finance is not negligible, and especially considering that 90% of world’s trade
relies in such instruments. Therefore, policies aimed at the alleviation of financial
conditions potentially contribute to ensure the smooth, reliable and predictable flow of
trade during financial crisis.
VI. RECOMMENDATIONS FOR FUTURE RESEARCH
Research on the role of trade finance should be resumed as more comprehensive
and reliable statistics becomes available. This would help to definitely shed light on the
diverging findings the academics have reached through the analysis of macroeconomic
data that, due to its incompleteness, can lead to biased conclusions that underestimate
the role of trade finance. Additionally, a vast majority of the research papers published
on the topic are flawed by an exclusively US-centric focus and thorough analysis of the
ASEAN, MERCOSUR and EU economies remain scarce. Hence more accurate
research scoping the whole picture of global trade and other regions would be beneficial
to policy-makers elsewhere in the world.
To conclude, my last recommendation would concern the research on the current
ability of developing countries to access the international trade system, complementing
the findings and proposals reached at the WTO, IMF and World Bank level, especially
when it comes to the reformulation of the Basel II and III frameworks. Remaining
liquidity issues in monetary markets of several developing countries show how the
liberalization of financial markets, when not accompanied by further development of
the financial system, does not by itself guarantee the access to trade credit and mitigate
the perception of counterparty risk. The impact of the phenomena of “South to South
cooperation” on economic development and trade in developing countries is also a
relevant issue pending investigation.

21. 20
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Learned in Recent Years?”. World Trade Organization, Economic Research and Statistics
Division, January 2013.
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