We study the interplay between bank and trade credit in emerging markets. We document that small and medium-sized enterprises (SMEs) trade off bank for trade credit, while large firms are more likely to extend trade credit, especially during financial crises. We develop a model of heterogeneous firms that extend state-contingent credit to each other along supply chains for the purpose of providing insurance in the case of adverse economic shocks. The model predicts that firms obtain more trade credit the less bank credit they have available, the larger is their scale of operation, and the more-debt constrained they are relative to their trading partner. Further, more debtconstrained firms receive more state-contingent trade credit from their less-constrained partners. We validate the model’s predictions using detailed firm-level data from emerging economies. We conclude that the insurance channel of trade credit earns it a role of a macroeconomic stabilizer in emerging markets.

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