Banks in International Trade: Incomplete International Contract Enforcement and Reputation  Morten Graugaard Olsen y November 11, 2010 JOB MARKET PAPER Abstract Banks are important facilitators of international trade. Besides providing liquidity they guarantee payment for around a fth of world trade, in particular when the contract enforce- ment of the importing country is weak. But if contract enforcement is too weak to trust the payment of an importer, why trust the importer’s bank? I argue that reputational mechanisms can provide the answer. Weak contract enforcement introduces a limited-enforcement problem, as the importer can renege on payment after receipt of the shipment, which repeated interaction alleviates. For importers too infrequently engaged in international trade to establish a credible reputation, a bank can increase credibility by guaranteeing multiple importers, but only if exporters can collectively punish the bank should it renege on one of them. Mutually conrmed bank guarantees over- come the need for collective punishment and further increase credibility as bilateral claims between banks reduce the net amount to be reneged on. In eect, mutually conrmed guar- antees partially transform international obligations into domestic obligations, which are more easily enforced. While this paper focuses on banks, reputational mechanisms can also shed light on both large intermediaries and export credit agencies. JEL codes: C73, F19, G21, L11, L14 Keywords: Trade Finance, Repeated interaction, Contract Enforcement, Reputation  I thank Pol Antr as, Oliver Hart, Elhanan Helpman, and Andrei Shleifer for invaluable guidance. I also thank Philippe Aghion, E Benmelech, John Campbell, Steve Cicala, Raluca Dragusanu, Adam Guren, David Hemous, Sabrina Howell, Greg Lewis, Marc Melitz, Alp Simsek, and Vania Stavrakeva for insightful conversa- tions, and the parcipants of the Harvard International Lunch and Seminar for helpful comments. All remaining errors are my own. y Morten Graugaard Olsen, Department of Economics, Littauer Center, Harvard University, Cambridge, MA 02138, mgolsen@fas.harvard.edu.