International Finance Discussion Papers (IFDP)

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November 2015

International Trade, Risk and the Role of Banks

Friederike Niepmann and Tim Schmidt-Eisenlohr

Abstract:

International trade exposes exporters and importers to substantial risks. To mitigate these risks, firms can buy special trade finance products from banks. This paper explores under which conditions and to what extent firms use these products. We find that letters of credit and documentary collections cover about 10 percent of U.S. exports and are preferred for larger transactions, indicating substantial fixed costs. Letters of credit are employed the most for exports to countries with intermediate contract enforcement. Compared to documentary collections, they are used for riskier destinations. We provide a model that rationalizes these empirical findings and discuss implications.

Keywords: Trade finance, multinational banks, risk, letter of credit

DOI: http://dx.doi.org/10.17016/IFDP.2015.1151

PDF: Full Paper

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Last Update: June 19, 2020