The International Monetary Fund (IMF) has published a comprehensive paper analysing what happens when banks' critical role providing guarantees through letters of credit (L/Cs) is compromised.

Using the case of the massive loss of faith in Greek banks in 2015, the paper found that subsequent intervention from a European Bank for Reconstruction and Development guarantee programme for Greek L/Cs significantly helped the country's traders obtain the finance they needed to sustain their businesses.

Pressure on L/Cs

Using the case of the Greek capital controls in 2015, the events around which led to a massive loss of confidence in the domestic banking system, the paper shows that firms whose operations were more dependent on domestic banks suffered a steep decline in imports and, subsequently, exports.

This operated through L/Cs, which during the capital controls period had to be backed by firms' own cash collateral rather than the bank guarantee. As a result, cash-poor firms imported relatively less, according to the paper.

Transaction guarantees

The authors found that public intervention to guarantee transactions however helped mitigate some of the decline in imports.

The paper looks specifically at the EBRD programme introduced to guarantee payment under L/Cs issued by local Greek issuing banks to international confirming banks, taking on credit risk of non-payment by issuing banks.

Intervention mitigates impact

From a domestic firms' perspective, no cash collateral was required after the EBRD took on the role of trade guarantor hence the cost of trade decreased.

The paper apparently shows that, economically, this programme reversed the negative impact of capital controls supporting trade for those firms with relatively tighter cash constraints.

The IMF paper, Guaranteeing Trade in a Severe Crisis: Cash Collateral over Bank Guarantees, can be downloaded from here.

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