# Executive Summary

Along with the rapid decline in trade during the latter half of 2008, the financial crisis may have reduced the supply of trade finance, raising fears that the lack of trade finance may deepen and prolong the recession. Various estimates have put the size of a possible trade finance “gap” in the range of $25-500 billion. Governments and multilateral institutions have responded with a range of trade finance programs, including a pledge by the G20 leaders at their April 2009 London Summit to ensure $250 billion of support for trade finance.

Historically, trade finance has tended to be highly vulnerable in times of crisis, as was the case in East Asia in the late 1990s. Indeed, trade finance differs from other forms of credit, such as investment or working capital, in ways that make it higher risk—during periods of crisis—because of the difficulty of securing and enforcing credible commitments across borders in times of turmoil.

In the current crisis, it is clear that access to affordable trade finance has been constrained. A number of banks, global buyers, and firms surveyed by the World Bank are reporting to be constrained by lack of trade finance and other forms of finance, such as working capital and pre-export financing. In addition, the costs of trade finance are substantially higher than they were pre-crisis, raising the problem of affordability for exporters. SMEs and exporters in emerging markets appear to be facing the greatest difficulties in accessing affordable credit.

Yet, available information also suggest that trade finance is not down to nearly the same degree as actual trade flows. Data from the IMF indicate that trade volumes declined by about four times faster than trade finance volumes during the period October 2008 through January 2009. In short, while the contribution of trade finance to the massive decline in world trade should not be overestimated, there is evidence that a trade finance shortfall participated in the drop of international trade and risks hindering its eventual recovery.

A critical question is therefore whether the decline in the supply of trade finance is the result of market and/or government failures, and, hence, whether there is a rationale for public intervention to address them. Two broad cases that would create a real trade finance “gap” would be where there is insufficient supply (i.e., “missing markets”) or where it is being supplied at prices that are temporarily too high to meet demand in the market (i.e., “overshooting markets”).

_Missing markets._ There are a number of reasons why bank deleveraging and risk-adjustment processes in response to the financial crisis might restrict the supply of trade finance more than other forms of bank credit, despite the fact that trade finance should be a relatively low risk product line in normal times.

First, there may be a temporary inability of the market to properly calculate risk – in other words, not a problem of risk per se but uncertainty, which is particularly acute in opaque and highly internationalized markets like trade finance. Second, information asymmetries in international markets have been exacerbated by a collapse of interbank trust and a hoarding for cash, raising the risk of interbank strategic default. Third, with the liquidity crisis forcing banks to recapitalise as quickly as possible, trade finance credit lines – the majority of which have terms less than 180 days – tend to be the first lines of credit banks cut. Finally, there may be strong political economy factors at play. As much of the response to the crisis has 2