The impact of the coronavirus pandemic on letter of credit (L/C) business is difficult to predict for several reasons. It is unclear how supply chains that L/Cs so often finance will be affected while trade finance flows are both inherently complex and extremely difficult to track and see on a global scale.

Clues indicating where the vulnerabilities of L/Cs may be tested can be seen in the comprehensive but now somewhat dated assessment of global trade financing flows published in January 2014 by the Bank for International Settlements (BIS).

Comprehensive survey

Trade finance: developments and issues looked at the size and composition of the trade finance market and found that trade finance directly supports about one-third of global trade, with around US$2.8 trillion of L/Cs covering about one-sixth of total trade.

But the proportion varies widely at the country level, with all bank-intermediated trade finance products estimated at US$6.5 trillion to US$8 trillion primarily used to finance trade involving emerging market economies (EMEs), particularly in Asia.

Asian exposure

Global banks appear to provide about one-quarter to a third of global trade finance, and almost half of their exposure is to firms in emerging Asia.

In EMEs for which data are available, local banks account for the bulk of the bank financing in support of trade.

Dollar availability

Trade finance is more US dollar denominated than global trade, with 80 per cent of L/Cs denominated in US dollars.

The ability of global and local banks to provide trade finance can be disrupted if banks' dollar funding lines are curtailed, as appears to have been the case in some instances in 2008/09, and again in 2011/12 the BIS report says.

Local bank difficulties

While US and global banks may be able to obtain sufficient US dollars as a result of central bank interventions to mitigate the impact of coronavirus, local banks may find it more difficult.

So in the current crisis it will be the local banks that are providing the lion's share of trade finance that may find it most difficult to obtain US dollars.

Off-balance sheet

Tackling L/C difficulties is compounded by the lack of trade finance data. To make matters worse, the available data cover only on-balance sheet lending activities.

L/Cs are treated as off-balance sheet, except to the extent they are tied to or become funded loans, by resident domestic banks with a focus on bank lending to domestic borrowers.

This article represents the views of the author and not necessarily those of the ICC or Coastline Solutions.