Trade Finance Use by Heterogeneous Firms

Letters of credit are a key trade finance instrument that covers more than 10 percent of global trade, with a notably larger role in low- and middle-income economies.

Letters of credit are a key trade finance instrument that covers more than 10 percent of global trade, with a notably larger role in low- and middle-income economies. Studying detailed trade data from Viet Nam, this paper documents how the use of letters of credit varies with firm characteristics. The paper shows that the probability of using a letter of credit is systematically lower for younger, smaller, and foreign-owned trading firms. Importers that are less diversified or have less trading experience are more likely to use letters of credit. Firm characteristics have the strongest effects in markets where information is scarce and enforcement is weak. These patterns are consistent with a model in which the ability to screen trading partners and the cost of bank intermediation vary with firm characteristics, and where a firm’s screening ability and country institutions are substitutes. Any policy or intervention that aims at increasing the use of bank-intermediated trade finance will therefore need to take firm heterogeneity into account.