Why trade finance is really about firms

Trade finance is a pillar of international trade, yet it remains one of the most understudied areas in international economics. The reason is simple: data is scarce. Banks do not publicly disclose details on the trade finance they provide, and only a handful of countries record payment methods when goods go through customs. Viet Nam is one of the rare exceptions. That made it possible to learn something we have long suspected but could not properly measure: the use of trade finance is not mainly about what firms trade or which country they trade with. It is, above all, about what kind of firm the trader is. 

Selling goods across borders is risky. Exporters who deliver on credit risk non-payment; importers who pay in advance risk non-delivery. This problem is especially acute in lower-income economies, where weaker institutions make contracts harder to enforce. Letters of credit, a financial instrument where banks step in to monitor transactions and guarantee payment, exist precisely to resolve this tension. They cover more than 10 percent of global trade flows, yet until now we have known surprisingly little about who actually uses them and why.

A new study, Trade Finance Use by Heterogeneous Firms, uses matched customs and industrial census data for the universe of Vietnamese firms from 2016 to 2022. The dataset includes millions of observations, from 500,000 to 700,000 firms per year, including over 40,000 trading firms, in one of the world’s most dynamic, diverse, and trade-oriented economies.

Much of what we currently know about trade finance focuses on transaction characteristics. We know, for example, that letters of credit are more beneficial in harder-to-enforce environments, for trade with more distant markets or for trade in more complex products. Our analysis based on Vietnamese firms shows that this was only part of the story. Firm characteristics explain two to seven times more of the variation in the use of letters of credit than the characteristics of the trade itself, such as the goods being traded or the destination country (Figure 1). For the literature on trade finance, that is a shift in perspective - one that was long overdue.

What makes some firms more eager to use letters of credit? The study points to two distinct potential factors: the cost of accessing a letter of credit and the firm’s own capability to manage cross-border risks without intermediation. On the cost side, bigger, older, and more productive firms tend to access finance on more favorable terms, making letters of credit a more attractive option even when they can manage the risk themselves.  On the capability side, importers with longer trading experience may have developed the know-how to vet foreign partners, and enforce agreements informally, reducing their need for bank intermediation over time.  For most firms these forces are at play simultaneously. Let’s consider foreign-owned firms which showcase this tension. Multinationals often trade with related parties (e.g., subsidiaries) across multiple countries, allowing them to monitor and enforce agreements directly. Their lower reliance on letters of credit reflects strength, not exclusion. Understanding whether cost or capability constraints prevail is an empirical question, essential for designing effective policy responses. 

Firm characteristics are more consequential for imports than for exports (Figure 2). By convention, it is the importer that typically bears the cost of a letter of credit. Firm characteristics also are more consequential when firms trade with countries where information is scarcer and contracts are harder to enforce. The study uses Vietnamese diaspora presence as a proxy for information availability and looks at differences in the strength of contract enforcement across countries. In these tougher markets, both bank access and firm capabilities matter more.

This new evidence has direct policy implications. Development institutions often discuss trade finance as a market-wide shortage, and that is true: unmet demand runs into the trillions globally, and research by the IFC and WTO suggests that improving access and lowering the cost of trade finance could raise trade materially in several developing regions. Through firm-level analysis, this paper adds a new layer to the conversation: it argues that expanding aggregate supply alone risks directing resources toward already well-served firms. Younger, smaller, and first-time traders face steeper barriers to access letters of credit and stand to gain the most from targeted interventions. Domestic importers also deserve more attention.

The deepest implication, however, concerns the relationship between trade finance and firms’ capability. Letters of credit do not merely shift risk; they ultimately substitute for organizational capabilities that some firms have yet to develop. Our findings show that trade finance and firm capability play separate roles in supporting international trade.  It is therefore essential to harness the potential of both levers when designing development interventions aimed at promoting trade.

Viet Nam’s data reveal that trade finance is not exclusively or primarily a feature of transactions, but rather of firms. And that insight opens a much richer agenda for research and policy alike.