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International Trade, Risk and the Role of Banks

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  • Friederike Niepmann
  • Tim Schmidt-Eisenlohr

Abstract

Banks play a critical role in facilitating international trade by guaranteeing international payments and thereby reducing the risk of trade transactions. This paper employs banking data from the U.S. to document new empirical patterns regarding the use of letters of credit and similar bank guarantees. The analysis reveals that trade finance is a large and highly concentrated business. It corresponds to roughly 20 percent of U.S. exports, with the top five banks extending more than 90 percent of the guarantees. We find that exporters use letters of credit the most when exporting to countries with intermediate levels of risk. Moreover, they rely more on this instrument in times when funding is cheap and aggregate uncertainty is high. However, firms do not respond uniformly to changes in global interest rates and risk. Those that ship to high and low risk countries adjust their use of letters of credit the most. A modification of the standard model of payment contract choice in international trade is needed to rationalize these empirical findings.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 4761.

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Date of creation: 2014
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Handle: RePEc:ces:ceswps:_4761

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Keywords: trade finance; multinational banks; risk; letter of credit;

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References

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  1. De Sousa, Jose & Mayer, Thierry & Zignago, Soledad, 2011. "Market access in global and regional trade," MPRA Paper 35602, University Library of Munich, Germany.
  2. Niepmann, Friederike, 2013. "Banking across borders," Discussion Papers 19/2013, Deutsche Bundesbank, Research Centre.
  3. Silvia Del Prete & Stefano Federico, 2014. "Trade and finance: is there more than just 'trade finance'? Evidence from matched bank-firm data," Temi di discussione (Economic working papers) 948, Bank of Italy, Economic Research and International Relations Area.
  4. Thomas William Dorsey & Mika Saito & Armine Khachatryan & Irena Asmundson & Ioana Niculcea, 2011. "Trade and Trade Finance in the 2008-20+L460609 Financial Crisis," IMF Working Papers 11/16, International Monetary Fund.
  5. Rauch, James E., 1999. "Networks versus markets in international trade," Journal of International Economics, Elsevier, vol. 48(1), pages 7-35, June.
  6. Galina Hale & Christopher Candelaria & Julián Caballero & Sergey Borisov, 2013. "Bank Linkages and International Trade," IDB Publications 83660, Inter-American Development Bank.
  7. Beck, T.H.L., 2002. "Financial development and international trade: Is there a Link?," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3125515, Tilburg University.
  8. Yeaple, Stephen Ross, 2009. "Firm heterogeneity and the structure of U.S. multinational activity," Journal of International Economics, Elsevier, vol. 78(2), pages 206-215, July.
  9. David Hummels & Georg Schaur, 2012. "Time as a Trade Barrier," NBER Working Papers 17758, National Bureau of Economic Research, Inc.
  10. Felici Roberto & Pagnini Marcello, 2005. "Distance, bank heterogeneity and entry in local banking markets," Temi di discussione (Economic working papers) 557, Bank of Italy, Economic Research and International Relations Area.
  11. Daniel Paravisini & Veronica Rappoport & Philipp Schnabl & Daniel Wolfenzon, 2011. "Dissecting the Effect of Credit Supply on Trade: Evidence from Matched Credit-Export Data," NBER Working Papers 16975, National Bureau of Economic Research, Inc.
  12. Andreas Hoefele & Tim Schmidt-Eisenlohr & Zhihong Yu, 2013. "Payment Choice in International Trade: Theory and Evidence from Cross-country Firm Level Data," CESifo Working Paper Series 4350, CESifo Group Munich.
  13. Nathan Nunn, 2007. "Relationship-Specificity, Incomplete Contracts, and the Pattern of Trade," The Quarterly Journal of Economics, MIT Press, vol. 122(2), pages 569-600, 05.
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