The value of collateral in trade finance

Abstract

Suppliers are subject to the credit risk of their customers when they sell products on credit. However, rights to the collateral value of the products they sell may mitigate some of this risk. This paper demonstrates the important role of laws that support suppliers’ rights to reclaim and liquidate collateral. Using a change in the US bankruptcy code that altered the rights of a subset of suppliers, I use a difference-in-differences setting to show that an improvement in suppliers’ rights to the liquidation value of collateral results in an increase in the amount and duration of trade credit offered. The increase in collateral protection also reduced suppliers’ lending standards, resulting in more dispersed trade credit lending and riskier customer portfolios. Finally, I find that the increase in collateral rights decreased suppliers’ incentives to monitor their customers, consistent with collateral and monitoring being substitutes. Overall, the paper shows that with strong legal protections in place, trade credit has an important collateral component.