Financial sector development and trade credit : a case of BRICS countries

Abstract

While there is a growing body of literature on trade credit’s role in short-term financing, few studies have examined the relationship between trade credit use and financial sector development. This study investigates the hypothesis that firms in countries with poorly developed financial sectors rely on trade credit. The main objective is to critically examine the relationship between trade credit and financial sector development. The study uses listed firms in emerging economies and evaluates the causality of the relationship using panel data econometric techniques. A quantitative approach was used to explain the underlying relationship between trade credit and financial sector development in Brazil, Russia, India, China and South Africa (BRICS). The research setting is on emerging economies that are committed to developing their financial sectors. The study investigates the relationship between financial sector development and trade credit use amongst listed firms in BRICS countries as well as the extent of trade credit usage in these countries. It also explores the relationship between banking sector development and trade credit use by firms. The study finds that financial sector development does not influence trade credit use by firms in BRICS countries and that current levels of trade credit cannot be explained by past values of such development. Trade credit is not Granger caused by financial sector development and financial sector development does not assist in predicting trade credit use by firms. On the contrary, trade credit Granger causes financial sector development in BRICS countries. Current levels of financial sector development can be explained by past values of trade credit use by firms. Trade credit Granger causes financial sector development and firms’ use of trade credit does help in predicting financial sector development. Finally, the study confirms the role of trade credit as an important source of finance for working capital within the trade credit-financial sector development discourse whilst also demonstrating the significance of banking sector development. An analysis of historical trade credit use in an economy helps to predict the level of financial sector development, which informs firms whether or not they need to increase bank loans or trade credit as sources of working capital. In light of these findings, it is recommended that firms in BRICS countries embrace efficient trade credit

management and adjust their policies in response to financial sector development in order to minimize their borrowing costs. Trade credit precedes banking sector development; therefore, it is important to the growth of firms before they gain access to bank credit or the banking sector itself develops. Bank managers and finance executives should study and analyse trade credit use patterns by firms because trade payables compete with bank loans. The implications of trade credit use for financial sector development and business-to-business relationships imply that this is an important area which should be regulated to reduce the probability of corporate default. Financial and international banking regulatory agencies should also study and analyse trade credit use as it has a causative and predictive effect on financial sector development.