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Trade credit, a risky game banks play


Trade credit, a risky game banks play

Trade credit is used for short-term import finance for a period of one year normally. The credit is extended by foreign suppliers or lenders. These are in other term called as supplier's or buyer's credit. Under supplier's credit, foreign suppliers extend credit for the relevant period; they receive payment at the end of tenure. On the other hand, foreign lenders make payments to suppliers at sight basis under buyer's credit for which they receive payments at the end of maturity.  

In Bangladesh, short-term import finance from external sources is permissible for import of specified goods like capital machinery, industrial raw materials and so on. The tenure is maximum one year.  Importers can import under supplier's or buyer's credit. But there is a peculiar equation: importers are not exposed to suppliers or lenders abroad. Rather importers' banks bear all responsibilities including payment obligations. How they are responsible for the transactions is a question. The simple answer is that external parties are taking exposure on banks which undertake commitments to make payments on maturity.  

Banks issue usance letters of credit with confirmation made by foreign banks under supplier's credit. After onboarding the shipments, suppliers' banks submit import bills to importers' banks which give acceptance with maturity data of payments. On maturity, banks need to settle payments of bill value accepted by them. On the other hand, foreign lenders or offshore banking operation of resident banks make payments directly to suppliers at sight basis based on import bills accepted by banks in Bangladesh. This is under buyer's credit for which banks establish import letters of credit on usance terms confirmed by other foreign banks. Relevant letters of credit contain conditions to pay to suppliers at sight basis by foreign lenders. Financing is made by lenders abroad based on acceptance of import bills by resident banks. On maturity, foreign lenders are paid with import bill value including interest. 

The benefits for the transactions to importers are interest cost savings since cost for financing by foreign currency is cheaper compared to financing by local currency. Banks, on the other hand, enjoy commission income, acceptance changes, and other fees against their exposure. But it is a risky game if collateral including margin for letters of credit is not sufficient. Importers are also in risky position with regard to exchange loss. Local currency may be depreciated to a large extent, leading to extra cost while on settlement of liabilities with banks on maturity. In that case, no extra benefits other than payments are made at deferred dates. 

There is a weight factor between banks and importers. Exposure by banks is well published with a disclosure to all corners. In case of default by banks, country image becomes jeopardised. But bilateral loan between lenders and borrowers is an internal issue between them. Non-payment issues go to arbitration or court for settlement. In that case, banks are no parties of the games; rather they are only facilitators to execute the transactions in accordance with set formalities. 

There are specified characters in supplier's and buyer's credit. Importers are borrowers, while lenders are either suppliers abroad or foreign financial institutions. But the system prevailing in Bangladesh market is a derivative of original product. Under buyer's credit, letters of credit issued on usance terms are confirmed by foreign banks which bear extra cost. This cost is higher compared to cost of acceptance charged by resident banks during the tenure. Such confirmation is merely required for imports under supplier's credit from regular suppliers. The confirmation on letters of credit by foreign banks works as additional comfort to foreign lenders making payments directly to suppliers against import bills accepted by resident banks.   

In real case of finance under buyer's credit, importers with the support of their banks arrange financiers for payments of imports. Importers import goods either through sales contracts or letters of credit with condition to make payments at sight. Suppliers ship goods and send documents through their banks to importers' banks in Bangladesh. Based on the compliant documents, lenders are requested to make payments directly to suppliers. Banks' obligations, in case of the transactions through letters of credit issued on sight terms, end on payments to suppliers by foreign lenders. For imports through sales contracts under buyer's credit, no payment obligation needs to be borne by banks excepting transactional services.  

The mechanism prevailing for so called buyer's credit is apparently cost effective at nominal point of view. But whether real cost is higher or not is a question. On the other hand, there is an unhealthy competition among resident banks for import trades. As a result, they take huge exposure on importers with simple assessment. Payment default, if so happens, leads banks to face real music. Is it the exposed situation behind super profits in external borrowings by importers? Should not they come out of being exposed externally? These are different questions coming into the situation.  

Let us move to foreign exchange regulatory framework for access to short-term external import finance. The framework says that buyer's credit from foreign banks and financial institutions is permissible for making specified import payments arranged through designated banks of importers at all in cost interest rate ceiling. This regulation is clear that foreign lenders will extend import financing to importers, banks will work as arrangers. On the other hand, offshore banking regulations of the country state that a bank, in its offshore banking operation, can discount bills accepted by importers' banks in Bangladesh against deferred/usance letters of credit. This regulation is a clear-cut instruction for import bills discounting by offshore banking operation. Under the framework, offshore banking operation should make discounted payments to suppliers abroad and realise full payments from importers' banks which have given acceptance on maturity. But inside information says that practice is different. Offshore banking operation does not discount accepted usance bills, rather they make payments in full value to suppliers for which they realise payments from importers' banks with interest as applicable for buyer's credit. This procedure is known as financing under UPAS (usance payments at sight) letters of credit. Such financing is, besides offshore banking operation, extended by foreign banks under UPAS model. Introduction of UPAS letters of credit has phased out normal usance imports under letters of credit, inside information indicates.  

The model gives comfort to importers since imports on credit from suppliers are said to be costly compared to imports at sight under UPAS financing. But this creates huge risk exposure by banks in their balance sheets resulting in high cost for confirmation services, correspondence services from counterpart banks abroad. Central bank can assess risk consumption ability by banks for the transactions under prevailing practices.  

Whatever findings are found, actual model of buyer's credit needs to be brought on to the screen for which importers should be encouraged. In this case, import of inputs can be allowed for 360 days or for the tenure up to cash operating circle, whichever is lower. General authorisation should be given to importers for extending corporate or personal guarantees, making assignments of cash receivables etc., to lenders abroad. These collaterals may help to avail actual buyer's credit for which importers themselves will be liable to make repayments of loans. This can make real markets for lenders to play with competition. Otherwise, they continue lending in the name of buyer's credit with recourse to resident banks. In the long run, the practice of huge risk exposure may create bar to our banks in making banking relations with counterparts for different services required in global transactions.  

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