Market Adjustment versus Market Failure
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• Limited or nonexistent data by which to assess counterparty credit risk in many countries (for example, where public credit registry coverage or public access to accounts or court proceedings are limited). These risks may be compounded in the case of supplier-extended credit because most suppliers operate in credit chains, which are vulnerable to shocks because they can quickly propagate problems across the chain (Kiyotaki and Moore 1997; Raddatz 2010). Impact of Financial Crises on Trade Finance Although trade finance was neither a proximate nor ultimate cause of the 2008–09 financial crisis, it quickly became collateral damage. As the crisis unfolded, the availability of trade finance tightened and its cost rose because of growing liquidity pressure in mature markets and a perception of heightened country and counterparty risks. However, with no comprehensive and reliable data on trade finance available, an overall assessment of trade finance developments in 2008–09 remains difficult. Historical precedents and selected information indicates that—along with global demand—trade finance flows declined in the last quarter of 2008. Trade finance has tended to be highly vulnerable in times of economic crisis. During crisis episodes in the late 1990s and early 2000s in Argentina, Brazil, Indonesia, the Republic of Korea, Pakistan, Thailand, and other emerging economies, local banking systems encountered liquidity and solvency problems that made it difficult for local producers to get pre- and postshipment finance, open letters of credit (LCs), and obtain advance payment bonds and other forms of domestic trade finance. In 1997–98, for instance, bank-financed trade credits declined by about 50 percent and 80 percent in Korea and Indonesia, respectively. During the crisis in Latin America in the early 2000s, trade credits in Argentina and Brazil declined by as much as 30–50 percent (Allen 2003). As noted in the next section, most banks reported a decline in the value of their LC business in 2008–09, and global buyers and suppliers indicated that foreign sales had been delayed or canceled due to both drops in new orders and difficulties in obtaining trade finance (Arvis and Shakya 2009). Evidence of liquidity pressure on trade finance was also reported by the banks participating in the Global Trade Finance Program of the World Bank Group’s International Finance Corporation (IFC). Major international banks in the program have been unwilling to assume a portion of the risk in individual transactions, leaving the underlying risk to the IFC alone (International Financial Consulting 2009). The firms most affected are generally those highly exposed to the international financial market (for example, in Brazil); small and medium enterprises (SMEs)