rigorous counterparty risk assessment contributed to higher cost of trade finance for importers, exporters, and financial intermediaries. By the end of 2008, trade finance deals were offered at 300–400 basis points over interbank refinance rates – two to three times more than the rate a year earlier. The cost of L/Cs was reported to have doubled or tripled for buyers in emerging countries, including Argentina, Bangladesh, China, Pakistan, and Turkey. This was confirmed in the IMF/BAFT survey, which found widespread increases in pricing of all trade finance instruments relative to banks’ costs of funds. More than 70 percent of respondents indicated that the price of various types of L/Cs increased because of an increase in their own institution’s cost of funds (80 percent of respondents), an increase in capital requirements (60 percent of respondents), or both. The survey indicates that the cost of trade finance instruments increased at an accelerating rate during the quarter October 2008-January 2009, while during the same period, the margin growth on short and medium term lending began to slow down. This seems to suggest a systematic reappraisal of trade finance risk and with it both a decline in the available supply of trade credit and an increase in its price (possibly to a level that cannot be supported by exporters).

Finally, in a recent attempt to disentangle the effects of trade finance from demand shocks using disaggregated bilateral import and export data from the US, Germany and Japan, Freund and Klapper (2009) show that trade in industries more dependent on inter-firm financing with countries more exposed to the crisis has not been affected more than overall trade. This suggests that trade finance has not been more adversely impacted than other types of financing that firms rely on. However, they also find some evidence that, in countries more affected by the crisis, trade in industries that are more dependent on short-term financing, broadly defined, has fallen more sharply. This implies that financial needs have played a role in affecting trade patterns during the crisis. However, the results do not necessarily suggest that trade finance has constrained overall trade growth; rather there has been a substitution away from firms in the most affected countries toward firms in less affected countries in industries with high financial dependence.

These findings reflect the fact that bank-intermediated trade finance is only a very small part of the story. In most cases, exporters are extending credit within the supply chain with payments made on open account and funding working capital / pre-export finance through retained earnings. This means that firms for the most part have actually not been as badly constrained by trade finance as one may have anticipated. Yet, the massive drop in export orders over September 2008-March 2009 means that the internal liquidity of these firms is likely to have dried up. So as trade starts to pick up again, firms that normally self-financed may need to seek a line of credit (working capital / pre-export financing) from banks. And the evidence from the surveys seems to suggest that this type of financing (rather than necessarily L/Cs and other guarantees) is where banks are becoming more selective and imposing adverse conditions (more collateral required and higher interest rates), particularly on SMEs. So while the interbank crisis of confidence may be over, there is still danger of a secondround effect that could constrain trade and hinder the recovery.

# 5. <u>Is there a rationale for intervention to address a trade finance “gap”?</u>

Although it is difficult to assess the nature and quantify the scale of a trade finance “gap”, what is clear is that trade finance volumes have not only declined significantly in nominal terms, but that they seem to have declined more than other forms of credit and perhaps more than what should be expected based on market fundamentals. A critical question is whether 11