Trade credit: A financial product that needs to be explored

Keyword: 
Financial institutions
Topic: 
Financial Economics

According to surveys carried-out by the Central Bank of Mexico, during the period 2009-2013 an average of eighty-two percent of businesses reported having used trade credit to finance their expenses. Furthermore, according to data released by the National Banking and Securities Commission of Mexico, trade credit financed sixty-seven percent of the total purchases made by firms who used such financing. Finally, according to the World Bank’s Investment Climate Survey (2010), trade credit was a more important source for financing investment in Mexico (15.6%) than in all Latin America and the Caribbean countries (7.5%) and it was also a more important source for financing working capital in Mexico (21.2%) than in Latin America (18.2%).

Sources of External Finance Mexico
Source: Central Bank of Mexico

Share of firmas that use trade credit
Source: Central Bank of Mexico


Why is trade credit so important in Mexico? Is it a reaction to the relatively small penetration of banks? Are trade credit and banking credit substitutes? Who provides trade credit? Who demands it and who uses trade credit? An answer to these questions could provide information that may help understand better how firms finance their expenditures and provide some insights about the true size of the credit channel of monetary policy. However, despite the importance of trade credit in Mexico an answer could not be found in published research that addresses these questions.

As a first approximation two questions emerge. First, what factors determine who demands and who uses trade credit; and second, what determines the value of trade credit. By answering these, we will indirectly be seeking to understand whether the existence of trade credit reflects: a demand for funding that is too small to be attractive for banks, a level of informality that prevents banks to efficiently measure credit risk, or maybe it exists just because some non-financial companies have enough liquidity and information that allows them to make a profit by providing funding to other non-financial companies.

For such purpose we draw on the data provided by a national survey - Encuesta Nacional de Competitividad Fuentes de Financiamiento y Uso de Servicios Financieros de las Empresas (ENAFIN)- that was designed by the Inter-American Development Bank, the National Banking and Securities Commission of Mexico and the National Institute of Statistics and Geography. Considering the 2009 National Economic Census, the sample of the ENAFIN was delimited to those firms that were in operation in 2008, employing six or more workers and located in cities with more than fifty thousand inhabitants. Coverage of the sample allows nationally representative figures, by size of company, for more than 280,000 economic units. The survey was made in the last quarter of 2010 and the information collected is for the previous year .[1]

Table 1: Some basic characteristics of the sample
Some basic characteristics of the sample

With the use of a probabilistic model in which a selection problem is considered, we find, among other results, that the decision to seek credit from suppliers’ increases the smaller the firm is, but the granting of trade credit is positively correlated with the size of the firm. Controlling by size, being engaged in transactions in which no formal invoice (those recognized by the tax collection authority) is delivered reduces the likelihood of using trade credit. Thus, informal transactions are costly for firms. For those sixty percent of firms that obtained –in our sample- financing from suppliers, the size of the company does not determine the average amount of funding. Rather, the delivery of formal invoices when selling goods and services and its use of banking credit products are the main factors that determine the average size of funding.

Our results suggest that the use of trade credit can not necessarily be used as anecdotal evidence of low bank financing. Trade credit appears to be used –even if firms have access and use banks’ products and services- because it is a cheap financial product. Having said that, we still need to understand why trade credit is so relevant in Mexico compared to other Latin American countries.


[1] According to the last national economic census, more than 95% of firms in Mexico employ less than 10 workers. Thus our results cannot be generalized. 

Reference
Cotler, P. “Does Trade Credit Say Anything about Banking Credit? Working Paper No.1, Economics Department, Universidad Iberoamericana, Ciudad de Mexico http://www.iberoeconomia.mx/index.php?option=com_content&view=article&id=149%3Adocumentos-de-trabajo&catid=37&Itemid=7

 

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