Easing trade finance crunches could lessen severity of crises

• Pages: 90-93

Page 90

IMF SURVEY: What prompted you to examine trade finance?

GILMAN: Bank-financed trade credits declined by as much as 30-50 percent in Brazil and Argentina in 2002, about 50 percent in Korea in 1997-98, and over 80 percent in Indonesia during the Asian crisis. Sharp declines in trade finance were also observed in Russia, the Philippines, and Thailand in 1997-98 and in Turkey in 2000-01. The scale of the collapse appeared to be out of proportion with the level of risk. After all, trade finance usually takes the form of short-term credits secured against goods that earn foreign exchange, and the default rate on this category of financing has traditionally been very low.

What concerned us is that a collapse in trade finance meant that a country's ability to export- and therefore to increase export earnings to help it get out of a crisis-could be seriously compromised. We wanted to determine whether there was any general pattern or common thread among these collapses. Another concern was whether something could have been done, in retrospect, to limit the extent of the collapse or mitigate its impact.

IMF SURVEY: What drove the cutbacks in trade credit-a reduction in demand or a shortfall in supply?

GILMAN: Indications are that supply-side factors were primarily responsible for the sharp decline in trade finance. In recent crises, in line with perceptions of heightened risk, banks raised interest rates, shortened maturities of credit lines, and charged higher fees for confirming letters of credit. In Brazil, for example, interest rate spreads on bank-financed trade facilities increased from about 1 percentage point to 6 percentage points over LIBOR and maturities fell from 360 days to as little as 30 days. Also, insurance, when it was needed, became more difficult to obtain as trade insurers tightened their coverage policies.

Banks, being leveraged institutions, are sensitive to perceived changes in risk and tend to reduce asset exposure to a crisis country to avoid large losses and potential insolvency. Ironically, trade credit lines are among the first to get slashed despite the fact that they are usually the least risky assets. Under pressure from shareholders, the nonrenewal of trade credit is the easiest, quickest, and cheapest way of reducing country exposure. In a market facing a crisis, participants engage in herd behavior-they all rush for the exit together.

IMF SURVEY: What are the main consequences of this sharp decline in trade...