Recent research from the Federal Reserve Bank of New York suggests that the letter of credit (L/C) shortage played a substantial role in the 2008/2009 trade collapse.

The report's authors, one of the bank's economists, Friederike Niepmann, and the University of Illinois' Tim Schmidt-Eisenlohr, also reckon L/C shortages can have a negative impact on trade even when there is no crisis.

Trade finance role

The authors suggest a "role for trade finance in explaining the trade collapse in 2008/2009, in particular with respect to trade in small and high risk countries."

The report entitled 'No Guarantees, No Trade: How Banks Affect Export Patterns', further found that a reduction in the supply of L/Cs, "has a large, causal effect on exports both in crisis and non-crisis times."

Different causes

With a focus on the activities of large US banks, the authors concluded that the impact of L/C shortages is not uniform.

They argue that L/C shortages cause more significant changes in trade for smaller countries and those considered riskier by the Economist Intelligence Unit's risk index.

In developed markets, a trade collapse may be precipitated by a drop in demand rather than an L/C shortage the report suggests.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.