Opting for international factoring

International factoring is rated as a better alternative to letter of credit as a means of payment for transaction of cross-border trade. The idea has come to the fore recently in Bangladesh because of persisting complications arising out of trade through Letter of Credit (LC) and is being tossed around by businessmen and financial planners alike.
Factoring is defined as a complete financial package that combines working capital financing, credit risk protection, accounts receivable book-keeping and collection services. It is offered under an agreement between a third party called 'factor' and a seller. Under this agreement the 'factor' buys the seller's accounts receivable and takes on responsibility for the buyer's ability to pay. If the buyer is unable to pay, the factor will pay the seller.
It is an open-account transaction where buyers are not required to furnish payment guarantee by a third party and is therefore more preferable to Letter of Credit (LC). Under LC an exporter entrusts the responsibility of payment collection to the remitting bank (exporter's bank), which sends documents to a collecting bank (importer's bank), along with instructions for payment. Funds are received from the importer and remitted to the exporter through the banks involved.
Factoring has become topical in the context of Bangladesh as export from Bangladesh is becoming diverse and complex every day and a financing option is imperative to help the country's import/export activities and to provide a means for its manufacturers and exporters to avoid problems associated with deferred payments from buyers.
Through factoring, instead of securing a loan, business owners sell accounts receivable (invoices) at a discount to a third-party funding source to raise capital. The source, or factor, then advances most of the invoiced amount to the company immediately and the balance upon receipt of funds from the invoiced party.
Factoring is a better option for businessmen on more than one account. Getting payments against export from the foreign buyer on time is a prerequisite for sustainable export and payment on time depends largely on the method of payment used. That is why regulators in Bangladesh are looking to incorporate factoring as a financing option.
According to business experts, importers are getting increasingly disinclined to import by opening LCs, as importers have to provide required margin and sufficient security to their banks under LCs. Even for a successful importer, there comes a time when the growing requirements for LC margin go beyond the importer's financing ability and LC coverage exceeds the security available to give to the bank. Moreover, importers need to approach banks for issuing LCs on each occasion of importing goods from abroad, which is really time-consuming.
In LC operation procedures, several banks, including issuing bank, collecting bank, negotiating bank, presenting bank, confirming bank, are involved. And therefore non-LC mechanisms, including open-account trade payment and documentary collection, are being progressively used as methods for international trade payment.
Additionally, involvement of too many banks creates barriers at different stages of operation and LC confirmation fees take away a substantial amount of foreign exchange outside the country and in this way cost of international trade goes up. To fulfill the demand of the importers for credit terms, our exporters may export under international factoring which is also as secured as LC.
International factoring provides a solution to the problems faced in case of open-account trade as the factor/bank collects money from abroad by approaching importers in their own country, in their own language and in the locally accepted manner.  
As the global economy becomes increasingly competitive, there is a growing feeling that companies must change their stance and be more flexible with customers to maintain and increase sales. Ability to offer international customers better financing terms is now a necessity to plan and execute any sales package.
Unlike domestic companies, payment from foreign companies involves elements of uncertainty and hence credit risk stands as a barrier. Selling on open account, which may be best from a marketing and sales point of view, is also fraught with danger. An exporter may not be able to find out the customer's financial situation and the economic situation of the country to which the customer belongs.
Also, collecting from foreign accounts is equally difficult. On the other hand, cash-in-advance also places the customer to a competitive disadvantage, as open account terms with extended time frame are becoming more frequent despite the dangers involved.
Most domestic banks will not provide the necessary financing on export receivables. This remains a critical issue as these receivables are now utilised as a financing tool in international trade programmes. International factoring is an attractive alternative in such cases and hence many exporters have added factoring companies to their list of financial partners.
Most Bangladeshi business houses are currently using letter of credit for settlement of their transactions. But the procedure of letter of credit is a very complex and time consuming one. The other methods available for such settlement are the open account, advance payment and documentary collection method.
But the businesses of Bangladesh do not use the other methods frequently due to their risk exposure and regulatory requirements. But currently factoring is being widely used by the businesses of different countries for settlement of international trade transactions. Some Asian countries are even using international factoring for that purpose.
Bangladesh may now introduce international factoring on a pilot basis in a bid to boost its overseas sales by reducing cost of import. However, certain regulatory changes will be required to do so, like, amendments in Foreign Exchange Regulation Act, export policy, and preparation of shipping documents.
Although international factoring has become more noticeable in recent years, it is not a new concept altogether. Factoring has been used in one form or other since the fifteenth century when merchandise, such as fish, fur and timber were exported to England with agents from London making loans and advances to these exporters to help them manage working capital.
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