International Trade, Risk and the Role of Banks

Banks play a critical role in international trade by providing trade finance products that reduce the risk of exporting. This paper employs two new data sets to shed light on the magnitude and structure of this business, which, as we show, is highly concentrated in a few large banks. The two principal trade finance instruments, letters of credit and documentary collections, covered about 10 percent of U.S. exports in 2012. They are preferred for larger transactions, which indicates the existence of substantial fixed costs in the provision and use of these instruments. Letters of credit are employed the most for exports to countries with intermediate degrees of contract enforcement. Compared to documentary collections, they are used for riskier destinations. We provide a model of payment contract choice that rationalizes these empirical findings and discuss implications for the ongoing provision of trade finance.