RMG trade promotion: Banking challenges

The concluding part a three-part series titled 'The role of banking in RMG trade.'

The readymade garment (RMG) sector and its trading activities have been experiencing several challenges and risks. Some of these challenges are associated with the trade payment, financing and other related services by the banking industry. Not very different from other countries, some of the challenges in Bangladesh are malpractices related to non-compliance of regulation or guidelines; some of these are intentional, while many of these are due to knowledge gap. Behaviour on the part of clients and their external counterparts are also prompting risks for the banks, traders, and the country.

Documentary credit remained the most prominent payment technique in import and export facilitation in Bangladesh's RMG. Documentary collection is extensively in use alongside documentary credit in the Export Processing Zones (EPZs). This, in general, is a sharp contrast to the global practice wherein most payment transactions take place through open account. Of the different types of letter of credit (LC), back-to-back and transferable LCs remained dominant that are clearly associated with the RMG sector development and trading of the country. There is no doubt that LC has certain limitations in terms of hazard, documentation and cost, however, it has been connected with the trade credibility of the country.

Concern over trade-based money laundering (TBML) and shadow banking are additional issues which make the use of LC and documentary collection more attractive in developing countries like Bangladesh. The country cannot afford to stay completely away from all recent developments under the banner of supply chain finance. However, the traditional use of techniques and background of the RMG must not be ignored. Moreover, trade digitisation and use of blockchain technology in the coming years might bring remarkable positive changes even in the use of so-called traditional methods of trade payment and financing. In regard to the use of trade payment methods, greater use of LC offers better protection, monitoring and control of the regulatory authority. Bangladesh is having favourable circumstance in this connection. Any attempt to move towards open account in line with global trend might prove to be risky from the point of view of TBML as well. At this moment, use of LC is not only linked with credibility, but also related to having right kind of regulatory control to address financial crime like TBML.

There are evidences that a good number of trade transactions in Bangladesh started on wrong foundation i.e., locally prepared pro-forma invoice. In most cases, the contract or purchase/sale agreements are not legally enforceable for ensuring optimum protection. Traders in several instances in RMG failed to undertake legal actions due to the weaknesses in purchase/sale contracts. Back-to-back LC against contracts is found to be relatively risky and prone to greater risks as compared to that against master LC. It is suggested that bank should not enter into contract-based export without satisfying creditworthiness of the exporter and the importer.

Creditworthiness of the counterpart and legally enforceable contracts are crucial for RMG traders. Contract Act as enforced in the country was not prepared for international trade transactions. Although 89 global countries ratified UN Vienna Convention as the regulatory guideline, Bangladesh is yet to do the same. For sound purchase/sale agreement, it is essential to have coverage of a regulatory framework. Alongside ratifying the UN Vienna Convention on Contract of Sale, there should be clear instruction on the trading with non-ratifying countries with regard to the guiding framework for all international trade transactions. It is also right time to undertake preparatory work for adoption with ongoing global trade digitisation movements.

Credit risk and default loan scenario in Bangladesh's trade services is not different from the non-performing loan (NPL) scenario in the country as a whole and RMG is no exception. In several instances banks had to create forced loans to adjust back-to-back liabilities in recent years. The country also faced several instances of scams associated with local back-to-back credits. There are significant instances of discrepancies with regard to LC documents in RMG trading. Since there is no specific law for governing the cases under documentary credit, there are frequent interventions of court refraining banks to honour its obligation on the plea of quality and/or quantity claim. This unwelcome trend may face decay over reliability of documentary credit in the RMG sector. Time has come to have a separate LC law for the country. This can be done either by enacting a separate law as in place in the US, China, Vietnam etc. Moreover, considering the unique nature of trade transactions and growing complexity, a separate bench in the court may be needed to ensure effective use of regulatory machinery.

It has been observed that banks generally perceive 'Credit report requirement on exporters' or 'KYC requirement on importers' as a compliance requirement rather than a risk management strategy. Sometimes, the contents seem to be very ordinary or not adequate to ensure basic information on the foreign counterparts. Credit report on the counterpart is particularly crucial for the traders. Several exporters, however, are not ready to obtain that or incur cost on that. The formats of credit reports obtained by different banks and their contents are generally different; some even seem inadequate. In such a circumstance, Bangladesh Bank (BB) may prescribe an ideal format or minimum information requirement as the content of a regular credit report.

There is no doubt that the activities of buying houses have been crucial for the development of the RMG in the country. Buying houses have been particularly supportive in materialising RMG export orders mainly using transferable LC in the country. It has also been performing the role of ensuring qualities of the exportable and issuing pre-shipment inspection certificates on behalf of the foreign importers. In some instances, the contacts and orders delivered by the buying houses were cancelled without any logical basis. There are also instances when some buying houses cause undue problems to the exporters by not issuing pre-shipment inspection certificate in due time. Earlier, buying houses used to obtain licences from BB. Now their activities are hardly regulated or monitored. Probably the activities of buying houses need to be monitored by an agency for safeguarding the interests of the traders. The Ministry of Commerce (MoC) is working on formulating a policy framework for the buying houses.

Incidence of trade-based money laundering (TBML) is a growing concern for policymakers and central banks throughout the globe and it is affecting RMG trade and the service providing bankers. Though the available sets of anti-money laundering (AML) rules are in line with globally accepted standards, there is still a lot of scopes for improving their enforcement and identify the applicable red flags in the context of the country. The country probably needs a customised guideline targeting its own TBML issues. Compliance is already the greatest concerns for the banks, and greater compliance requirements are affecting the operational costs of trade financing. Reporting system has a role in this connection. Enforcement of online reporting and monitoring system by the BB have brought positive changes in terms of decline in irregularities by banks and improvement in data accuracy. Banks have the obligation of ensuring the prices of importable items 'competitive' and the prices of exportable items 'fair'. Therefore, they have to find out an effective mechanism to implement the obligation. The problem remains although the customs offered a list of minimum prices for selected tradable items. The country needs greater coordination amongst different stakeholders to address pricing issues and country risks for competitiveness and regulatory compliance. Greater coordination with the customs has already brought positive changes in addressing the challenge. Collective efforts from FEPD and BFIU of the BB and the customs authority are the prerequisite for greater enforcement of AML rules.

There is no doubt that the quality of trade services rendered by the banks has improved remarkably over the years with the growing number of certified professionals in the area. Changes are particularly visible in payment operations. However, there are deficiencies in the level of expertise among service providers on the financing issues at different stages of the long value chain of RMG. For efficiency in financing components, role of external stakeholders are particularly crucial alongside internal efficiency. In spite of initiatives for capacity development and support on part of the banks, increase in the compliance cost has become concerning, and there are apparent instances of cost-saving efforts, and excessive work-load on the executives of trade service departments. Alongside investing in capacity development of the bank executives, awareness initiatives for the RMG traders should get due emphasis to minimise the prevailing risks.

Dr. Shah Md. Ahsan Habib is Professor and Director (Training), Bangladesh Institute of Bank Management (BIBM). [email protected]