Why A Letter of Credit is not used in Domestic Trade?

  1. 1.   Introduction:

 In the age of globalization, international trade is growing rapidly. In mainly international trade, letter of credits are commonly used as method of payment[1]. The Letter of credit, as we know the term today, existed in England by the time of the 17th century[2] when the bill of exchange[3] had matured into an instrument similar to the drafts used today. While the letter of credit was developed to facilitate international commercial transaction involving the sale of goods, there is nothing about letter of credit which limits their application to international trade. Letters of Credit have been a cornerstone of international trade dating back to the early 1900s[4]. They continue to play a critical role in world trade today[5]. For any company entering the international market, Letters of Credit are important payment mechanisms which help eliminate certain risks[6]. In Bangladesh, L/C is the chief legal method of international transactions. Lack of real time information on the transactions and goods clearance with the Central Bank is the primary reason behind the existence of a conventional payment mechanism such as the L/C[7].

I would analyze the above topic in two parts; firstly what are a Letter of Credit and its need, secondly, letter of credit and its relation with international trade and domestic trade.

  1. 2.   Letter of Credit:
  1. A.  Definition of Letter of Credit

 Letter of credit means “An instrument under which the issuer (usually a bank), at a customer’s request, agrees to honor a draft or other demand for payment made by a third party (the beneficiary), as long as the draft or demand complies with specified conditions, and regardless of whether any underlying agreement between the customer and the beneficiary is satisfied. In international sales transaction, a contract for the sale of goods is usually executed in conjunction with a banker’s documentary credit to secure the prompt payment of the contract price. The arrangement to pay through banker’s documentary credit is called letter of credit[8].” A standard, commercial letter of credit (LC) is a document issued mostly by a financial institution[9], used primarily in trade finance[10], which usually provides an irrevocable payment undertaking. Letters from a bank which give guarantee that a buyer’s payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase[11].

 Letters Of Credit, also called documentary credits, are the most frequent methods of payments for goods in the export trade[12]. They have been described by English judges as “the life blood of international commerce”[13]. Donaldson L.J., with the occurrence of Ackner L.J., said[14]:

            “Irrevocable letter of credit and bank guarantees given in circumstances such that they are equivalent to an irrevocable letter of credit have been said to be the life blood of commerce. Thrombosis will occur if, unless fraud is involved, the courts intervene and therapy disturbs the mercantile practice of treating rights there under as being equivalent to cash in hand.”

The feature common to all type of letter of credit is that the buyer arranges with a bank to provide finance for the exporter in the country of the latter on delivery of the transport documents. On presentation of the transport documents, the banker pays the purchase price, often by accepting a sight draft or time bill drawn by the buyer (acceptance credit) or by paying cash (Cash Credit). A letter of credit has been described in these terms[15]:

“The Banker acting on behalf of the buyer and either directly or through the intervention of a banker in the seller’s country, assumes liability for payment of the price, in consideration, perhaps, of the security afforded to him by an implied pledge of the documents of title to the goods or of his being placed in funds in advance or of an undertaking to reimburse, and of a commission.”

 This description reveals the essence of the transaction, viz. that where the goods are represented by the bill of lading, this document of title is used as a means of financing the transaction. Lord Wright[16] describes the function of the letter of Credit as follows:

The general course of international coerce involves the practice of raising money on the documents so as to bridge the period between the shipment and the time of obtaining payment against documents[17].

            A comprehensive delimitation of the letter of credit is to be found in the Uniform Custom and practice for Documentary Credit (1983 Revision)[18] where it is provided[19]:

For the purpose of these articles, the expressions “documentary credit(s)” and “standby letter(s) of credit”[20] used (hereinafter referred to as “credit(s)”), mean any arrangement, however named or described, whereby a bank (the issuing bank), acting at the request and on the instructions of a customer (the applicant for the credit),[21]

  1.         i.            is to make a payment to or to the order of a third party (The beneficiary),[22] or is to pay or accept bills of exchange (drafts) drawn by the beneficiary, or
  2.       ii.            Authorizes another bank[23] to effect such payment, or to pay, accept or negotiable such bills of exchange (drafts).
  1. B.   The stages of a letter of credit transaction:

When payment under a letter of credit is arranges, four stages can normally be distinguished[24]–

  1.                                 i.            The exporter and the overseas buyer agree in the contract of sale that payment shall be made under a letter of credit.
  2.                               ii.            The overseas buyer instructs a bank at his place of business (known as the “issuing bank”) to open a letter of credit for the United Kingdom exporter on the terms specified by the buyer in his instructions to the issuing bank.
  3.                             iii.            The issuing bank arranges with a bank at the locality of the exporter (known as the “advising bank”) to negotiate, accept or pay the exporter’s draft upon delivery of the transport documents by the seller.
  4.                             iv.            The advising bank informs the exporter that it will negotiate, accept or pay his draft upon delivery of the transport documents. The advising bank may do so either without its own engagement or it may confirm the credit opened by the issuing bank[25].

From these transaction steps we can understand that it is mostly used for international trade because in the domestic trade these terms would not be applicable.

  1. C.  Laws governing international letter of credits:

There are mainly two intergovernmental institutions that make rules governing international letter of credits[26]

1)      United Nations Commissions of International Trade Law (UNCITRAL)[27],

2)      International Chamber of Commerce (ICC) and National and Local Laws. Guidelines or model law published by intergovernmental institutions are not binding to any of its member states but businesses can adopt this law as governing law[28].

Apart from these intergovernmental institutions national and local governing laws are very important in deciding issues. Particularly in deciding jurisdiction of court and governing laws[29], local and international laws are very important factors. Most governmental allows parties to the contract to decide what law will apply in case of disputes with some restriction and after checking validity of contract[30].

  1. D.  Needs of Letter of Credit:

The letter of credit advance international trade by assuring sellers that they will receive prompt payment for goods they ship overseas to unknown buyers. In international trade neither seller nor buyer knows credibility of each other[31]. How buyer, when placing order of goods over the seas, be assured that the goods is according to his need and how seller, when shipping goods over the seas, be confident that he will get payment. In such contract the question is who will perform his obligation of contract first- should buyer pay first or should seller ships the goods first. Here the role of financial institutions and banks comes to focus. Usually information about credibility of financial institution and banks are easily available across the world. So instead of relying on credibility of contracting party, it is safer to rely in credibility of foreign banks and financial institutions[32].

  1. E.   Reason for using letter of credit:

Letter of credit are used for the following reasons-

To protect against buyer risk[33]

To protect against country risk[34]

  • A Credit risk from change in the credit of an opposing business.
  • An Exchange risk is a risk from a change in the foreign exchange rate.

To protect against these risks, a confirmed letter of credit will be necessary- a bank in the seller’s country will (for a fee) add its own payment undertaking to that of the issuing bank[35].

Letters of credit are also used as part of exchange control or import control regimes operating in the buyer’s country. In such cases the use of letter of credit is mandatory, even if not required by the seller for security reasons[36].

  1. 3.   Letter of Credit and International Trade vs. Domestic Trade

 A Letter of Credit is a payment term mostly used for long-distance and international commercial transactions. Letters of credit are essential for international transactions since they ensure that payment will be received[37]. Using documentary letters of credit[38] allows the seller to significantly reduce the risk of non-payment for delivered goods, by replacing the risk of the buyer with that of the banks. Letters of credit have become a crucial aspect of international trade, due to differing laws in each country and the difficulty of knowing each party personally[39]

  1. A.     International Trade:

 Before talking more about letter of credit, let’s look at broader picture of international trade. International trade is the exchange of goods and services between countries. This type of trade gives rise to a world economy, in which prices, or supply and demand, affect and are affected by global events[40].

B.     Domestic trade:

 Domestic trade, also known as internal trade or home trade[41], is the exchange of domestic goods within the boundaries of a country. The importance of domestic trade in a country is that it facilitates exchange of goods within the country.

  1. C.    Differences between international business and domestic business:

An international business is a business whose activities are carried out across national borders. This differs from a domestic business because a domestic business is a business whose activities are carried out within the borders of its geographical location.

A domestic company is one that confines its activities to the local market, be it city, state, or the country it is in[42]. The international company on the other hand deals with businesses and governments in one or more foreign countries[43].

 International trade is more difficult and risky for a firm than is domestic trade. In foreign trade, the exporter may not be familiar with the buyer, and thus not know if the importer is creditworthy[44]. If merchandise is exported abroad and the buyer does not pay, it may prove difficult, if not impossible, for the exporter to have any legal recourse. Additionally, political instability makes it risky to ship merchandise abroad to certain parts of the world[45].

  1. D.    Reason for using L/C in International Trade:

A Letter of Credit is a payment term mostly used for long-distance and international commercial transactions. Letters of credit are indispensable for international transactions since they ensure that payment will be received. “Letters of credit have become a crucial aspect of international trade, due to differing laws in each country and the difficulty of knowing each party personally[46].” After trade between countries made it impossible to do business by traditional payment methods, Letters of credit make it possible to do business worldwide[47].

International trade laws sound good and look good on paper, but are often difficult to enforce when dealing with a foreign party. So most international transactions are secured using a financial tool known as a Letter of Credit[48]. A Letter of Credit may be required in cases when a party does not have sufficient financial history, assets, or credit to support good faith credit terms[49].

The typical letter of credit is not very familiar in purely domestic transaction as a form of payment. The cost and the lengthy process make the letter of credit an unappealing form of payment for domestic transaction. In contrast, the popularity of letter of credit, as a tool of payment in international business transactions, increased because it is comparatively safe and speedy method of payment in lake of unified law[50]. Additionally, International Chamber of Commerce (ICC) is actively participating in unifying the rules regarding the letter of credit. Today, the 6th edition of Uniform Customs and Practice for Commercial Documentary Credit (UCP 500), published by ICC[51], generally familiar to regulate the transactions involving letter of credit[52].

Letters of Credit are now outdated with international trade occurring everyday and many multinational companies located all over the world, Letters of Credit have become a burdensome time consuming task[53]. Companies have developed trust in each other and consider it very important to honor contracts or purchase agreements[54]. A letter of credit is a promise to pay. Banks issue letters of credit as a way to ensure sellers that they will get paid as long as they do what they’ve agreed to do[55].

Letters of credit are common in international trade because the bank acts as an uninterested party between buyer and seller. For example, importers and exporters might use letters of credit to protect themselves. In addition, communication can be difficult across thousands of miles and different time zones. A letter of credit spells out the details so that everybody’s on the same page[56].

  1. E.     Reason for not using L/C in Domestic trade:

In the case of domestic trade, the need for L/C gets less importance. L/C is basically a bank guarantee which ensures payment so in domestic trade where the parties knows each other or can get credit references easily don’t go for L/C procedure as it is a long and costly method. Moreover, L/C is used for minimizing the risk of default payment so it is more in international trade then in domestic trade because one can use the domestic court if the buyer fails the payment. So, in particular, it can be said that the relative risk is more in international trade then in domestic trade which indicate a clear reason for using a letter of credit exclusively for international trade. In addition, the exclusive use of a letter of credit in international transactions exacerbates a collapse in trade during a financial crisis[57].

 Exchange takes time. For example, when a seller receives a purchase order that stipulates payment after delivery, the seller has to produce and ship a product before the buyer pays. This requires financing over short horizons because the seller may need to borrow working capital to complete the order or may purchase credit insurance to protect against counterparty defaults. That is the essence of trade finance[58].

International trade is more costly than domestic trade; hence the volume of international transactions will be smaller than domestic transactions[59]. Firms borrow from local banks. Banks need to gather information about whether loans will be repaid[60]. They need not only worry about the firm they loan to, but also any other firm on whose solvency repayment depends[61]. Banks invest more in learning about firms with which they have a larger volume of transactions, which in turn makes them more knowledgeable about these firms[62]. Since banks have larger transactions with domestic than foreign firms, they will also be more knowledgeable about them. This makes international trade finance loans riskier than domestic finance loans[63].

 Banks assess this overall transaction risk through screening tests for the borrower’s trading partner as well as the borrower[64]. By investing in information acquisition, banks can improve the precision levels of screening tests, and hence the loan repayment probability of the transactions that pass the screening tests[65]. The optimal precision levels of screening tests are determined by comparing costs and benefits[66]. All else being equal, since costly trade results in a larger volume of domestic transactions than international transactions, banks will maintain a higher accuracy level of screening test for domestic firms than foreign firms[67]. Accordingly, the screening of foreign firms yields a less accurate outcome than domestic screening, making international transactions a relatively higher risk with lower loan repayment probability. Therefore, costs of financing international transactions will be higher[68].

 The asymmetric nature of the screening tests for domestic and foreign firms gives rise to a letter of credit system exclusively for international transactions[69]. Under a letter of credit system, both a buyer’s bank and a supplier’s bank participate in the transaction as intermediaries. The buyer’s bank promises to pay the supplier’s bank on behalf of the buyer as long as the goods are delivered from the supplier, and the supplier’s bank guarantees to pay the supplier whether the buyer’s bank actually pays or not[70]. From the view of the supplier’s bank, this essentially switches the non-payment risk from the buyer to the buyer’s bank, and thus can replace an inferior screening test for foreign firms by the supplier’s bank with a superior screening test for domestic firms by the buyer’s bank. This is the gain from using a letter of credit system for international transactions[71]. At the same time, however, since the supplier’s bank has only limited, imperfect information on the credit risk of the buyer’s bank, it incurs additional inter-bank informational friction[72]. As long as the gains from a letter of credit outweigh the costs, a letter of credit would be chosen as the optimal payment system for the transaction. Clearly, this will not be true for domestic transactions because it only incurs additional costs without any gains[73]

  1. 4.   Conclusion:

International trade allows us to expand our markets for both goods and services that otherwise may not have been available to us. Specifically, the letter of credit ensures guaranteed payments and perform financial intermediation role. In the international trade, buyers and sellers are separated by thousands of miles or even tens of thousands of years, do not know each other. Importers, exporters can expect on time delivery, when payment is to check whether the goods in line with the contract, the best resale of the goods for payment later. In this period the bank hopes to get financial intermediation. Exporters want to get the goods shipped before the bank’s financial intermediation, post-shipment loans can be guaranteed. The letter of credit bank guarantee is the primary payment responsibility of the issuing bank, in which payment is conditional discharge to ensure that the purchase price of both import and export goods of the right of the document and representation will not be disappoint. But in domestic trade these kind of situation don’t arise. However,  Letter of credit are used in domestic trade, although not as frequently, because shipping times are shorter and companies more frequently know each other or can get credit references, and they can use domestic courts if the deal goes bad.

So by considering all the aspect of Domestic and international trade it can be said that Letter of Credit is used in International Trade and to some extend in Domestic trade. But the disadvantage is there is no set format or rules that govern the domestic L/C unless they are subject to UCP.

[1]Due to the physical distances between buyer and seller, and the fact that the transaction may have taken place without the two parties actually meeting, minimizing exposure to risk is on the minds of both parties.

[2]By the 17th century letters of credits were common financial instruments both in the European continent and in England. At this time they functioned more like a traveler’s cheque. By the 19th century British banks had a virtual monopoly on the issuance of letters of credits. This was due to the fact that in world trade the Pound Sterling was the most accepted currency and the bankers of London gained a pre-eminent position in the field of international finance.

[3]In Britain, a bill of exchange is defined by the Bills of Exchange Act 1882 as an unconditional order in writing addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time a certain sum in money to or to the order of a specified person, or to the bearer.

[4]By the 1950s letters of credit had earned a predominant position in domestic commerce of the United States and were also widely used in international transactions.

[5]A quick general introduction to the origin and basics of letters of credit may be found in Gao Xiang and Ross C. Buckley. (2003), The Unique Jurisprudence of Letters of Credit: Its Origin and Sources, 4 SAN DIEGO INT’L L. J. 91.

[6] See, Blackburn, M. (1994), The Legal Environment of Business, 4th ed. P. 475. Para: 3.

[7]See, Hossain, N. (2000), Ecommerce in Bangladesh: Status, Potential & Constrain, USAID. P. 2.

[8]See, Madura, J. (2010), International Financial Management, 9th ed. P. 532. Para: 2.

[9] Financial institutions are composed of organizations such as banks, trust companies, insurance companies and investment dealers.

[10]In general, trade finance refers to any type of financing that uses trade credit (i.e., accounts receivable) as collateral. This paper defines international trade finance only as a letter of credit and working capital financing for international transactions, opposed to domestic trade finance defined as working capital financing for domestic transactions. The main result of the model will be readily extended to other types of trade finance facilities (e.g., export credit insurance) by introducing risk averse agents.

[11]See, Dr. S.R.Myeni. (2000), International Trade Law, 10th ed. P. 732. Para: 3.

[12]Greenaway, David, Alessandra G. and Richard K. (2007), “Financial Factors and Exporting Decisions,” Journal of International Economics, volume: 73(2), p. 377-395.

[13]Kerr L.J. in R.D. HArbottle (Mercantile) Ltd. v. National Westminster Bank Ltd. [1978] Q.B. 146, 155; Griffiths L.J. in power curber International Ltd. v. National Bank of Kuwait S.A.K. [1981] Lloyd’s Rep. 394,400; Donaldson L.J. in Intraco Ltd. v. Notis Shipping Corporation of Liberia. The Bhoja Trader [1981] 2 Lloyd’s Rep. 256, 257; Ackner L.J., ibid; and Stephension L.J. in United City Merchants (Investments) Ltd. v,Royal Bank of Canada [1982] Q.B. 208, 222.

[14]In Intraco Ltd. v. Notis Shipping Corporation of Liberia. The Bhoja Trader, supra.

[15]H.C. Gutteridge and Maurice Megrah, The Law of Banker’s Commercial Credits (6th ed., 1979), p. 1; this passage is not reproduce in the 7th ed., 1984. See further A.G. Davis, The Law relating to Commercial Latter  of Credit (2nd ed., 1954); E.P. Ellinger, Documentary Letter of Credit (1970); F.M. Ventris, Banker’s Documentary Credits, (2nd ed., 1983); Michael Rowe, Letters of credit (1985

[16]In T.D. Bailey, Son & co. v. Ross T. Smyth & Co. Ltd. (1940) 56 T.L.R.825, 828.

[17]This passage was quated with approval by Ackner L.J. in United City Merchants (Investments) Ltd. v. Royal Bank of Canada [1982] Q.B. 208, 247.

[18]ICC Brochure 400. The Uniform Customs and Practice for Documentary Credits 1983 (Brochure 400) must not be confused with the Uniform Rules for the Collection of Commercial Paper 1978 (Brochure 322), discussed on p. 332, ante.

[19]In art. 2.

[20]On standby letter of credit, see p. 363 post.

[21]This is the buyer

[22]This is the seller (exporter), but as the underlying transaction may be another than a contract of sale, the neutral expression “beneficiary” is used.

[23]This is normally the advising bank at the seller’s place

[24]Ralph, H. Folson. (2000), International Trade Law, 7th ed. PP. 235-236.

[25]Sometimes the situation is more complicated. The issuing bank may authorize another bank (e.g. at a major trading center in the seller’s country) to confirm, and this bank may instruct a third bank (e.g. in a mall place at which the seller carried on business) to advise the irrevocable and conformed credit. But no bank would confirm a credit if the issuing bank has not made it irrevocable; see UCP, art. 10 (b).  On conformed and unconfirmed credits, see p. 358, post.

[26] Clive M. Schmitthoff. (2007), The Law & Practice of International Trade, 8th ed. P. 478.

[27]UNCITRAL is a UN organization specializing in codifying and unifying international trade law. UNCITRAL’s business is the modernization and harmonization of rule on international business. In harmonizing process of law regarding letter of credits, UNCITRAL issued very good model laws and treaties.

[28]International Chamber of Commerce (ICC) was founded in 1919 to serve world business by promoting trade and investment, open markets for goods and services, and the free flow of capital. A year after the creation of the United Nations in San Francisco in 1945, ICC was granted the highest level consultative status with the UN and its specialized agencies. ICC has relation with almost all the countries. ICC is represented by national committee and groups. That way ICC’s rules are becoming global rules of business and accepted by all. ICC has contributed to basic legal structure of letter of credits to promote international trade by issuing landmarks sets of following rules and model laws. See also, International Chamber of Commerce (2010), “Rethinking Trade Finance”

[29] 2001- United Nations Convention on the Assignment of Receivables in International Trade. 1995- United Nations conventions on Independent Guarantees and Stand-by Letter of Credit. 1992- UNCITRAL Model Law on International Credit Transfers. 1998- United Nations Conventions on International Bill of Exchange and International Promissory Notes. Uniform Customs and Practice for Documentary Credit (UCP 500) (new rules of UCP 600 published by ICC in October 2006 but yet to take effect). Supplement to UCP 500 for Electronic Presentation (e UCP). Uniform Rules for Demand Guarantees (URDG) (ICC Publication No.458). International standby Practice (ISP98)

[30]Jason Chuah. (2009), Law of International Trade, 3rd ed. P. 328.

[31]Antràs, Pol and Fritz Foley (2010), “Poultry in Motion: A Study of International Trade Finance Practices”, 8th ed. P. 1119. Para: 3.

[32]See, Indira Carr. (2009), Principals of International Trade, 7th ed. P.731. Para:2.

[33]Where buyers are of unknown creditworthiness, letter of credit provide the seller with the security of a bank’s payment undertaking.

[34]The buyer may be willing and able to pay; but economic or political conditions in the buyer’s country may prevent or delay payment. This is a real concern when dealing with less developed countries and/or countries with periodic foreign exchange shortages.

[35]E.P. Ellinger. (1970), Documentary Letter of Credit, 2nd ed. P. 255. Para.3.

[36]See, Schaffer, Agusti, Dhooge. (1996), International Business Law & It’s Environment, 8th ed. P. 1121.

[37]Petersen, Mitchell and Raghuram Rajan (1997), “Trade Credit: Theories and Evidence”, Review of Financial Studies, vol: 10(3), P. 661-691.

[38]Documentary letters of credit help the importer significantly reduce the risk connected with the seller not meeting its delivery obligations. The imported goods will be delivered in accordance with all the conditions specified in the letter of credit, and the agreed-upon documents will be received relatively quickly.

[39]Jeffrey, S. Wood. (2008), Drafting Letter of Credit: Basic Issues Under Article 5 of the Uniform Commercial Code, UCP 600 & ISP98. P. 8.

[40]Political change in Asia, for example, could result in an increase in the cost of labor, thereby increasing the manufacturing costs for an American sneaker company based in Malaysia, which would then result in an increase in the price that you have to pay to buy the tennis shoes at your local mall. A decrease in the cost of labor, on the other hand, would result in you having to pay less for your new shoes.

[41]Mohammad Saiful Alam (2009), Law of Dictionary, 4th ed.

[42]It deals, generally, with one currency, local customs and cultures, business laws of commerce, taxes and products and services of a local nature.

[43]It is subject to treaties, tariffs. Currency rates of exchange, politics, cultural differences, taxes, fees, and penalties of each country it is doing business in. It may also be conducting business in its home country, but the emphasis is on trading in the international marketplace.

[44]Beck, Thorsten (2002), “Financial Development and International Trade: Is There a Link?” Journal of International Economics, Volume: 57(1), Page: 107-131.

[45]See, Michael Rowe. (1985), Letter of Credit, 3rd ed. P. 266. Para: 3.

[46] Venedikian Harry and Gerald War.eld (2000), “Global Trade Financing”, 10th ed. P. 195. Para: 4.

[47]See, A.G. Davis. (1954), The Law Relating to Commercial Letter of Credit, 2nd ed. P. 385. See also, Mc Carty, Baghy. (1993), The Legal Environment of Business, 3rd ed. P. 469. Para: 2.

[48]Flannery, Mark (1996), “Financial Crises, Payment System Problems, and Discount Window Lending”, Journal of Money, Credit and Banking, volume:  28(4), p: 804-824.

[49]James. G. Barners. (1994), Defining Good Faith Letter of Credit Practices, 5th ed. P. 105. Para : 3.

[50]Yusuf, M. A. and Sinha, M. R. ( 2000), Transaction in Foreign Exchange: Principles & Practices. P. 115. Para: 4.

[51]The International Chamber of Commerce (ICC) publishes internationally agreed-upon rules, definitions and practices governing Letters of Credit, called “Uniform Customs and Practice for Documentary Credits” (UCP). The UCP facilitates standardization of Letters of Credit among all banks in the world that subscribe to it. These rules are updated from time to time; the last revision became effective January 1, 1994, and is referred to as UCP 500.

[52]Jeffrey, S. Wood. (2008), Drafting Letter of Credit: Basic Issues Under Article 5 of the Uniform Commercial Code, UCP 600 & ISP98

[53]Muûls, Mirabelle (2008), .Exporters and Credit Constraints. A Firm Level Approach, London School of Economics working paper.

[54] Yilmaz, Kamil and Varma, Sona, (1995), Bangladesh: Industrial Surveys and Studies Program, Trade Policy Reform in Bangladesh, International Economics Department/ South Asia Country Dept. I, The World Bank, Washington, DC.

[55]Roeland F. Bertrams. (2000), Bank Guarantee in International Trade, 6th ed. P. 345. Para.3.

[56]Elliot, Klayman, John. (1996), Irwin’s Business Law, 8th ed. P. 965.

[57]Inessa, Lorenzo Preve, and Virginia Sarria-Allende (2007), “Trade credit and Financial Crises”, Journal of Financial Economics. Volume: 83(2). Page: 235.

[58]It is often described as the lifeline of business transactions because more than 90% of transactions involves some form of credit, insurance or guarantee (International Trade Center, 2009).

[59]Ali, Syed A. (1995). Foreign Exchange and Financing of Foreign Trade. P. 2.

[60]Pritsker, Matthew (2010), “Knightian Uncertainty and Interbank Lending”, mimeo Federal

Reserve Board.

[61]Smith, Janet (1987), “Trade Credit and Informational Asymmetry”, Journal of Finance, vol: 42(4), P. 863-872.

[62]Chowdhury, L. R. (2000),  A Textbook on Foreign Exchange, Fair Corporation, Dhaka. P. 156. Para: 3.

[63]When a crisis brings adverse loan supply shocks, banks will cut international trade finance loans first. As a result, the relative price of export to domestic goods will rise, and the volume of international transactions will drop more sharply than the volume of domestic transactions during a crisis.

[64]The screening technology adopted in this paper follows closely the ones developed in banking literature. Broecker (1990) introduced this particular form of technology in the context of inter-bank competition in credit markets. Flannery (1996) also modeled an identical type of screening test to show the possibility of loan market failure due to an increase in uncertainty during a .nancial crisis. Freixas and Holthausen (2004) incorporate the screening test into the inter-bank loan market. Hauswald and Marquez (2003, 2006) use the framework to study banks competition through information acquisition. Unlike them, this paper explores the cyclical property of the screening test and endogenizes its precision level.

[65]Schmidt-Eisenlohr, Tim (2009), “Towards a Theory of Trade Finance”, European University, Institute working paper.

[66]Bhattacharya Debapriya and Mostafizur Rahman, (1997). Bangladesh: Trade Related Technical Cooperation Needs Assessment, A Country Position Paper, the Ministry of Commerce, Government of the People’s Republic of Bangladesh.

[67]Iacovone, Leonardo, and Veronika Zavacka (2009), “Banking Crises and Exports: Lessons from the Past,” World Bank working paper 5016.

[68]Auboin, M. (2009), “Restoring Trade Finance During a Period of Financial Crisis: Stock- Taking of Recent Initiatives”

[69]According to the Society for Worldwide Interbank Financial Telecommunication (SWIFT), nearly 90% of letters of credit transactions are cross-border transactions (ICC, 2010).

[70]Burkart, Mike and Tore Ellingsen (2004), “In-Kind Finance: A Theory of Trade Credit”, American Economic Review, Volume:  94(3), Page: 569-590.

[71]Rahman Mustafizur, (1993), Export Performance, Possibilities and Constraints: Production and Market Issues, University of Dhaka for WB Study on Bangladesh. Page. 396. Para: 2.

[72]Freixas, Xavier and Cornelia Holthausen (2004), “Interbank Market Integration under Asymmetric Information”, Review of Financial Studies, volume: 18(2), page: 459-490.

[73]JaeBin, Ahn. (2010), A Theory of Domestic and International Trade Finance, Columbia University, Institute Working Paper for IMF.

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