International trade finance has seen a growing demand in Bangladesh with rapid increase in export and import alongside other economic activities. Bangladesh has a projected export target of US$50 billion by the year 2021. While the domestic banking system has limited resources, it can tap funds from the global banking system. Interestingly, these finances do not require any security mortgage. The relationship of Bangladeshi banks with overseas banks is only for transaction of receipt and payment against international trade. These traditional transactions rely on donor's credit line to finance international trade.
The policymakers and regulators should amend existing trade rules and start introducing financial products that meet ever-growing demand for modern and cost-effective finance without a mortgage. These can be secured through modern banking system.
A widely used financial system is standby letter of credit (L/C) and guarantee. These are offered by banks in other countries and can be considered for introduction in Bangladesh. Some other financial products are:
ACCEPTANCES: A banker's acceptance is a short-term debt instrument issued by a company that is guaranteed by a commercial bank. An acceptance is an unqualified promise of the acceptor to pay the face amount of the draft at its maturity. Banks 'accept' a draft by signing the draft with the name of the institution, signature of officer(s), date, possible nature of underlying transaction, and other information depending on the circumstances. Most acceptances cover a commercial transaction that is considered to be self-liquidating in nature, such as a commercial L/C. Bankers' acceptances of export documents are a potential source of financing for an exporter as there is a readily available market to sell the acceptance at a discount on face value. A banker's acceptance remains a common financial instrument in trade finance activities.
During an international trade arrangement, countersigning or endorsement of a bill of exchange by the buyer's or importer's bank is a precondition for payment guarantee. A banker's acceptance establishes that payment of the bill on the date of its maturity is now guaranteed by the endorsing bank. Banks agree to countersign a bill of exchange when they are comfortable with the buyer's financial strength and stability, and on payment of the acceptance fee. A bill of exchange is accepted by a bank usually for the purpose of financing a sale of goods to or by the bank's customer.
OPEN ACCOUNT FINANCING: Open account financing aids international trade against contract not guaranteed by commercial or standby L/C. There is no bank acting as the intermediary as is in the case of commercial L/C. There is no robust multilateral legal framework to govern contractual and payment obligations. Open account trades involve no bills of exchange or drafts as trading documents. This happens on the basis of historical trust between buyer and seller.
Although banks are not direct parties in open account transactions between buyers and sellers, banks finance either or both buyers and sellers. They take the role of financing the seller by providing purchase order financing or accounts receivable financing and buyer with deferred payment.
PURCHASE ORDER FINANCING: The importer or exporter may approach the bank to provide financing to the exporter based on the purchase order placed by the importer. The need for purchase order financing may arise from the length of time it takes to go from order to production to delivery and payment of goods.
In this form of pre-export financing, the bank assumes the exporter's ability for producing goods and the importer's repayment risks. Bangladeshi garment exporters import raw materials like fabric and accessories from other countries for making garment items that are exported. The L/C for raw materials is opened against the export L/C of garment buyers. Such back-to-back L/C for raw materials of exporter against export L/C from their buyer is an example of purchase order financing.
ACCOUNTS RECEIVABLE FINANCING: Sometimes, buyers finance the exporter through L/C for export. A bank may enter into accounts receivable financing with an exporter based on an existing relationship with the importer. The risk to the bank comes from the importer. This form of financing allows the exporter to obtain an early payment from the bank at an interest rate commensurate with the importer's credit standing. The advances to the exporter are discounted at a percentage of outstanding sales invoices. It becomes beneficial for the importer as more favourable purchasing terms can be negotiated with the exporter.
A recently introduced 'TASDIR' of the First Security Islamic Bank Limited (FSIBL) for financing export is a financial product of such kind. FSIBL has a collaboration agreement with Prima Dollar Finance Limited of UK. FSIBL receives payment from Prima Dollar and pays the bill to the exporter upon presentation and Prima Dollar conversely collects the payment after a deferred period.
FACTORING: Factoring is an arrangement under which a company shortens its cash cycle by selling its accounts receivable, traditionally without recourse, to a third party known as a factor. The system involves two factors - one from importing country and the other from exporting country - without involvement of banks in either country. In many countries, banks are in factoring business through their subsidiary companies. These factors assume the full risk of collection, including credit losses. There are two basic types of factoring: (1) discount factoring, in which the factor discounts the receivables before the maturity date, and (2) maturity factoring, in which the factor pays the client purchase price of the factored accounts at maturity. Factors in importing country perform all servicing functions in connection with accounts receivable and deal with factors in exporting country. Because the factor takes on credit risks, it is important that the factor fully understands the terms and associated credit risk.
FORFAITING: Forfaiting presents all of the risks associated with factoring, along with risks associated with long-term nature of purchased receivables. Factoring involves short-term export transaction and forfaiting is for long-term financing but it also has similar aspects as factoring. While a factor normally purchases a company's short-term receivables, a forfaiting bank purchases notes that are medium to long-term receivables. Usually, these transactions are endorsed by an "aval", a guarantee in the event of insolvency of the debtor from a foreign bank. Forfaiting is widely used in Europe and is also gaining acceptance in Asia.
COMMODITY TRADE FINANCING: Banks providing commodity trade financing are usually larger institutions with in-house expertise in commodity trade finance necessary for structuring transactions and managing commodity trade finance portfolios. Commodities traded include energy (e.g., oil and gasoline), metal (e.g., silver, copper, zinc, nickel, and aluminium), and agricultural (e.g., wheat, soybeans, corn, coffee, cocoa, sugar, and cotton) products.
Under this financing procedure, a commodity trader makes a purchase from a producer against L/C for export. The bank takes security over the underlying commodity through the bill of lading and assignment of receivables from sale and delivery of the commodity. Usually, the borrower has no independent capacity to repay the transaction. Commodity trade financing presents risks associated with the borrower (credit risk), the specific commodity financed (market, price, and liquidity risks), and monitoring the loan portfolio (operational risk). Typically, a timing gap exists between the purchase and sale legs of a transaction, exposing the transaction to commodity price risk, thereby requiring the commodity trader to hedge the risk.
Some banks in Bangladesh purchase commodities, such as oil, metal, cotton, yarn and food grains against international tender and negotiation and pay against L/Cs. At present, Bangladesh is the largest buyer of raw cotton in the world. The price and availability of commodity and the global trading system are different from our policy. We cannot buy from growers or manufacturers as we cannot engage into a transaction with them according to the market system. As such, Bangladesh purchases commodity products from second or third tier traders or stockists at higher prices.
HEDGING SERVICES: The hedging service is at the heart of all trade finance schemes. Hedging is a guarantee to the seller for a minimum sale value. It also guarantees to buyer for maximum price of purchase. Hedging strategies help banks control or reduce risks like price risk, interest rate risk, foreign exchange risk, and country risk. Similarly, both importer and exporter may use the bank to help develop a hedge against a specific transaction, a complete hedging strategy, or anything in between. Hedging is a market mechanism that spreads the risk of price fluctuations. It would be unusual for the trade business lines to actually develop or implement the hedge. Bangladesh can buy commodities at lower price with support of hedging system.
Bangladesh is already a lower-middle income country and on course to formally graduate from the least developed country status. In order to sustain this progress and economic growth, businesses need various trade financing products to facilitate global trade and also to offset upcoming challenges of losing duty-free and quota-free export facilities as well as the ability to get lower interest loans from the donor agencies.
MS Siddiqui is a legal economist. [email protected]
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