Possible transmission of adverse shocks from the recent financial crisis to Central America through trade finance

Abstract

In this paper we explore trade finance as a transmission channel of adverse shocks to Central America. We analyze data on trade and trade finance flows, and show that they largely follow the same pattern in the region. A contraction of trade finance supply to Central America will affect trade exports negatively, and consequently impact economic growth and jobs. While until now the region has weathered the financial and European debt crises relatively well, shocks may come from a further contraction of lending in developed countries. The lending contraction can arise from losses from the recent financial crisis that have not yet been fully recognized on the balance sheets of financial institutions, from regulatory changes in raising capital requirements, and from further adverse shocks, such as the lack of a solution to the euro area sovereign debt crisis, or from all of the above. Finally, we put forward policy recommendations to mitigate the risk of transmission of shocks through trade finance to Central America.