The importance of banks in foreign trade is often underestimated. Banks provide liquidity and guarantee payment for roughly 20% of world trade. The global financial crisis of 2008 highlighted how important banks are to trade. The crisis caused a major disruption to international bank lending, which was directly followed by a significant drop in international trade.
The crisis shone a light on the financial and economic interdependence of countries, and it also caused people to question how financial globalization influences trade. It is obvious to state that access to finances and enhanced domestic financial development are facilitators of international trade. It is also apparent that financial crises can give rise to the collapse of trade. However, the nuanced relationship between banks and international trade remains unclear to most. Here, we reveal the four main ways in which banks can facilitate trade.
The Four Ways That Banks Can Facilitate Global Trade
Banks can facilitate foreign trade in many ways. First, banks can support access to external finance by directly moving funds to the exporting country from international markets, or by raising funds locally. They can also achieve this by increasing competition in local banking systems, which has the knock-on effect of reducing the cost of financial intermediation.
Second, banks can provide necessary financial products to exporters. For example, they can be relied on for letters of credit to enable them to access funds. They can also provide derivatives to hedge currency risk. These financial products are usually only provided by specialized banks with a global reach.
Next, foreign banks are likely to lend funds to exporters if they can limit trade-specific contracting problems. The downside here is that the lack of strict enforcement on international contracts means that selling financial products overseas has greater risks, which can then negatively impact trade. Studies have shown that certain mechanisms, however, can reduce these risks, such as reputation, customized contract terms, and bank guarantees like letters of credit.
Finally, there is evidence that foreign banks are more likely than local banks to lend to companies involved in export as they are more likely to overcome information asymmetries. If the foreign banks present in an importing country are also present in an exporting country, this facilitates the flow of information and reduces risks for both parties. A good example of how this works is apparent in trade within the US. If trade is to take place between two states where the bank is present in both locations, it facilitates the collecting and sharing of information, and, in doing so, lowers risks.
Banks are important for facilitating trade. In some circumstances (as described above), foreign banks are positioned to provide more benefits to international traders. Therefore, collapses in trade are expected in times of financial crisis. Lending has always been important to traders, and now, in times when some of the world’s biggest economies are under threat following the pandemic, it is important that traders are aware of how the two sectors are closely intertwined. Exporters and importers who are more knowledgeable on such matters may be more likely to endure times of global financial crises.
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