Does trade credit substitute bank credit during crisis period? A Review of recent literature

Abstract

Although earlier studies on trade credit have made good progress and provided evidence that adds to our understanding of the role of trade credit they don’t reach a unanimous conclusion. This highlights a clear gap in the existing literature. The objective of this study is to fill the gap in the literature by providing an extensive review of the role of trade credit, especially during crisis periods.

Since this is a review paper, therefore it does not involve any econometric modeling or statistical methods for validating its claim. The method of this study is based on the interpretation of the results of existing studies. 

There is conflicting evidence regarding the role of trade credit during the crisis period. However, the currently dominant practice in finance is to view trade credit as a substitute for bank credit, especially for small firms. Since small firms face high market frictions and have limited access to market finance, therefore when rationed by banks during a financial crisis, these firms move towards high implicit cost trade credit to offset the reduction in bank credit.

This paper presents a review of the empirical literature on the use of trade credit for financing motives. Its aim is to provide an insight into whether trade credit serves as a substitute or complement during the crisis period. The review concludes that small firms face a high information problem. This information problem becomes worsens during an economic downturn or tight monetary conditions. As a consequence firm’s particularly small firms move towards trade credit to undo the bank lending channel.

JEL Classification Code: F17, F18, G01, M48