Trade Credit and Financing Instruments

Lucia Gibilaro

• Publisher: Business Expert Press
• Year: 2018
• ISBN:
  9781948976022
• Topic: Business
• Subtopic: Business General
• Index: Business

This book offers managers a complete analysis of the various facets of commercial credit and presents an analysis of the various types of markets, instruments, and risks associated with trade credit in supply chains across the globe.

Trade credit is extensively used in both domestic and international commercial transactions. Although it clearly supports growth, its significance is even greater for developed countries, where the market has recovered remarkably since the global financial crisis. The number and heterogeneity of motivations to trade credit justify the variability observed in the data on global trading, and the role of trade credit has become crucial in supply chain coordination.

A range of diverse trade credit finance solutions are available and include products and services offered by financial intermediaries and market products, highlighting a very interesting set of intermediate solutions that have emerged as a result of new technologies utilized in financial services. For financiers trade credit is an attractive option, but an in-depth evaluation of the possibility of losses forms the basis of a deep understating of numerous sources that can create credit risk (default and dilution risk). This book offers managers a complete analysis of the various facets of commercial credit and presents an analysis of the various types of markets, instruments, and risks associated with trade credit in supply chains across the globe.

CHAPTER 1

Trade Credit around the Globe

Introduction

Trade credit originates from the development of business relationships, and new motivations for using trade credit have been discovered over time. The flexibility and up-to-date attributes of trade credit in addressing multifaceted needs emphasize its diversified nature. A uniform approach to the analysis would thus overlook the richness of the information that can be extracted from the segmented analysis of firms’ recourse to trade credit. Such information is deemed particularly useful for trade credit financiers in appreciating the potential for growth and the selection of proper financing instruments in a changing environment.

This chapter presents an analysis of trade credit at the international level. First, since the assessment of trade credit in international transactions is still an issue due to the lack of availability of data, a long-term estimation has been obtained by identifying the contributions of different groups of countries that differ geographically as well as in terms of economic development (see Trade Credit around the World section). Since geography alone cannot sufficiently explain trade credit usage, further segmentation by industry is proposed for developed countries (see ­Industry Segmentation section). The diversification of motivations affecting firms’ usage of trade credit justifies further analysis by firm type for a select group of European countries (see Segmentation by Firm Type section). Last, a multidimensional analysis simultaneously examines geographical, sectorial, and firm-type categories in the usage of trade credit (see Synthesis: Multidimensional Segmentation section). Conclusions section concludes the chapter.

Trade Credit around the World

One way to develop interfirm relationships is through trade credit, that is, client’s delaying payment for goods purchased from and services provided by vendors in well-established trade relationships. Motivations for using trade credit are multifaceted (see Chapter 2); it is therefore a persistent and global phenomenon in financial transactions. Growing firms invest in trade credit to develop interfirm relationships (Summers and Wilson 2003) in both domestic and international trade. A moderately in-depth analysis of trade credit must be conducted at the global level because national standards in collecting data are not homogeneous and the need for greater improvements in this area has also been expressed at the international level (Development Working Group 2011).

The degree to which trade credit supports international trade has been extensively discussed and has garnered distinct attention, particularly since the 2008 global financial crisis, as characterized by a correlated drop in trade finance and trade at the peak of the global downturn (­Asmundson et al. 2011), showing that shortages of trade credit and trade finance services can affect international trade growth (International Chamber of Commerce, or ICC 2016). The measurement of such gaps, however, has been difficult due to definition issues. Trade finance assumes various financial obligations, with different degrees of risk mitigation and lending involved in facilitating the movement of merchandise between importer and exporter and vice versa (Baft-Ifsa 2011). Therefore, it encompasses both traditional bank-intermediated financial instruments and direct interfirm loans (Amiti and Weinstein 2011).

Recent estimates show that more than the half of the volume of international trade finance is supported by trade credit, and bank-intermediated trade finance services support 20 to 40 percent of international trade (Committee on the Global Financial System 2014). In light of relevant changes in time series on trade credit published by the Task Force on Finance Statistics (TFFS 2016), a reliable estimation of trade credit in international trade has used data on short-term trade credit insurance¹ provided by Bern Union (Auboin and Engemann 2014). Specifically, the Berne Union collects quarterly data on short-term credit limits² by destination country. Therefore, the ratio of the credit limit to the amount of imported goods and services provided by the World Trade Organization indicates the importance of the extension of trade credit to international trade for a given country. At the global level, trade credit accounted for an average of 22 percent of international trade during the past decade, with modest variability since the global financial crisis and a current upward trend (ICC 2016). The patterns of the different geographical areas are correlated with global patterns, even though Europe and Central Asia, the Middle East and North Africa, and Latin America and the Caribbean appear to rely more on trade credit in international transactions compared with other geographical areas (Figure 1.1). In particular, Western Europe plays a leading role in trade finance markets, whereas China does not, and, at lesser levels, North America’s contribution to international trade credit has recently started to grow again (ICC 2016). Among the reasons for the increase in the value of trade finance, financiers predominantly point out the increase of trade activities (International Monetary Fund, or IMF, and Baft-Ifsta 2011).

Income analysis shows that higher-income countries rely more on trade credit in international trade compared with middle- and low-income countries, even though all groups show growing reliance since the drop during the global financial crisis, with remarkable acceleration in the first quarters of the previous year in the analyzed timeframe (Figure 1.2). Consistent with the increase in the importance of the role of trade finance in facilitating activities in emerging Asian countries (IMF and Baft-Ifsta 2010) and supporting poor trade (ICC 2016), recent years show low- and lower-middle income groups overtaking the upper-middle income group (ICC 2016). Therefore, trade credit contributes to development.

The role of trade credit is crucial in supporting international trade, but it is even more important in supporting domestic transactions as has been happening in developed countries. Trade credit ranks among the most important sources in the financial structure of firms in G7 countries (Rajan and Zingales 1995; Fitzpatrick and Lien 2013), and a positive net trade credit position supports investments (Beck et al. 2008), despite relevant variability both within and between countries (Seifert et al. 2013). Figure 1.3 shows the share of trade credit in total assets in the G7 countries between 2007 and 2015. European countries have a higher contribution of trade credit in total assets; moreover, the incidence of trade credit appears to be cyclical, even though it smoothens out after 2011. Anglo-Saxon countries and Japan are characterized by a ...