Interfirm Trade Finance: Pain or Blessing during Financial Crises?
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However, if it is true that interfirm trade finance may be a mechanism of propagation of shocks, it is also true that the repeated business interactions among these firms may provide relevant benefits, especially during a financial crisis. The typical fear that lack of trust in times of extreme uncertainty may squeeze intermediated trade finance, exacerbating the effects of the crisis, may be less of a problem for firms operating along supply chains. These firms are often involved in long-term relationships and, thus, are less likely to experience an uncertaintydriven contraction in financing.4 This might also explain why trade credit is often countercyclical.5 In times of recession, banks are more concerned about credit risk and less willing to extend credit. Firms that rely more on relational contracts can increase their reliance on trade credit; the relationship of trust with the supplier makes up for the higher credit risk. Conversely, firms that rely on intermediated finance (formal contracts) are likely to be squeezed by the credit contraction because the higher credit risk and the lack of a credit history will discourage suppliers from extending them credit. The Role of Institutions One factor of crucial importance in determining the availability of international trade finance is the legal system in which trading countries operate. Inefficiency of the judicial system or of the legal system in general—in the form of inadequate contract law or bankruptcy law—increases enforcement costs and thus commercial risk. This inefficiency affects the cost and the availability of financing, thus hampering international trade. How does the legal system affect interfirm credit? A number of papers find evidence that trade credit is relatively more prevalent in countries with worse legal institutions and lower investor protection (Demirgüç-Kunt and Maksimovic 2001; Beck, Demirgüç-Kunt, and Maksimovic 2008). This seems puzzling because one may expect that better legal institutions facilitate all types of borrowing, including trade credit. This finding can nevertheless be explained by noting that, unlike financial intermediaries, trade creditors may be able to more effectively enforce contracts without resorting to the legal system by stopping future supplies. This intuition seems to be confirmed by a study, based on 1997 survey data from small and medium-size manufacturers in transition countries, concluding that ongoing relationships are more likely to be preserved when goods are complex, assets are specific, and it is difficult for customers to resort to alternative suppliers (Johnson, McMillan, and Woodruff 2002). According to other studies, the varying efficiency of countries’ legal systems might be related to their varying legal origins (La Porta et al. 1998). More precisely, countries belonging to the common law tradition are found to have more efficient