Offshore banking in Bangladesh and impact of recent regulatory changes

Offshore banking in Bangladesh came into being in 1985 through a Bangladesh Bank circular, mainly to create greater financing opportunities at the Export Processing Zones (EPZ). Since then it has become popular among business enterprises as well as banks in Bangladesh due to its capacity to attract global settlements and foreign currency financing facilities. According to a report in the Financial Express, total outstanding loan from Offshore Banking Unit (OBU) has crossed BDT 600.0 billion. Currently, 35 banks are actively participating in offshore banking, most of whom are doing business for discounting of import and export bills, and also for extending long term foreign currency financing facility to the corporates.

According to the 1985 BB Circular, OBU was free to accept deposit/borrowing from overseas entities including non-resident Bangladeshis (NRBs) and free to lend to Type-A (wholly foreign owned) EPZ enterprises. Type-B (partially foreign owned) and Type-C (only local ownership) enterprises were also allowed to avail OBU term loans subject to approval from the Board of Investment (now known as Bangladesh Investment Development Authority or BIDA). Afterwards, Bangladesh Bank relaxed regulations to allow various businesses to get facilities from OBU including discounting facilities of import and export bills. OBU was exempted from certain provisions of Banking Company Act 1991 including waiver from maintaining CRR and SLR, statutory capital and reserve or liquidity requirements. Interest payable on foreign currency liabilities in OBU was also exempted from payment of income tax.

NEW OBU POLICY: Bangladesh Bank has come up with a comprehensive guideline on Offshore Banking Operations on February 25, 2019 to bring offshore banking under a stringent regulatory framework. The new policy offered a lot of changes and imposed restrictions on export financing and others. Later on, Bangladesh Bank eased the policy by amending few of its clauses through the revised circular issued in May 27, 2019.

The major changes brought into the policy amendment include the following:

● Allowing local companies to avail foreign currency loan subject to approval from Bangladesh Bank

● Exporters to avail short term financing against shipments, which is popularly known as export bill discounting

● Joint venture companies operating in export processing zones/economic zones/hi-tech parks to avail short term loan facilities without prior approval from Bangladesh Bank.

The revised policy also addressed a few other issues such as allowing banks to borrow/lend from/to other OBUs in Bangladesh, waived from maintaining separate nostro account etc.

MAINTENANCE OF CRR AND SLR: The biggest challenge of the new policy is to apply Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) on OBU liabilities which has not been waived or restated despite appeals from different bodies. The magnitude on the bank's OBU for managing this additional liquidity (CRR: 5.50 per cent & SLR: 13.00 per cent; together 18.50 per cent) would be challenging while the industry is already facing liquidity challenges. This decision will significantly reduce the industry's loanable fund and create pressure on local currency liquidity. The main impact will be in terms of maintenance of a portion of CRR in local currency and almost entire amount of SLR in local currency; i.e. if we consider BDT 600. billion as OBU liability, then BDT 111 billion would be required for CRR & SLR. This is a hefty additional requirement for the banks effective from September 01, 2019 to maintain with Bangladesh Bank or through Bangladesh Bank approved securities or in nostro accounts.

INCREASED OBU BORROWING COST: Imposing CRR and SLR on OBU liabilities will increase the OBU funding cost significantly which will make OBU loans unattractive. The cost impact on OBU for applying CRR & SLR would be around 0.50-0.80 per cent p.a. for each dollar of OBU liabilities. Other impacts include maintaining provisions for OBU exposures, preserving capital and Interest payable on OBU liabilities are subject to Withholding Tax which was earlier exempted. Moreover, the lending rate for import and export bill discounting is capped at LIBOR+3.50 per cent p.a. which may not be reasonable enough to offset the cost of borrowing along with CRR and SLR cost, provision, capital charge, and operational costs. If we consider average cost of borrowing LIBOR+ 2.00 per cent, CRR & SLR cost 0.60 per cent, provision, capital charge, and operational costs, it will be really difficult to lend within LIBOR+3.50 per cent as capped by Bangladesh Bank. 

GLOBAL OBU PRACTICES: The main purpose behind the establishment of OBU was to extend foreign currency lending at a lower cost to eligible borrowers to facilitate trade finance and long term project financing. As of now, most of the transactions in OBU are on discounting of local import and export bills under Usance Payable at Sight (UPAS) arrangement while a smaller part in project finance or long term loans. Another objective was to attract more international investment by offering tax and other benefits. Globally, most of the offshore banks are located in jurisdictions that offer low taxation, or no taxation, commonly known as 'tax haven' countries. Offshore banks which are located in stricter regulatory jurisdictions, many of them being subsidiaries of larger onshore institutions, however operate under a separate flexible foreign exchange guideline. In most of the jurisdictions, capital requirement for OBU is either non-existent or extremely low, and taxes, VAT and other forms of levies are practically non-existent. Neighbouring countries like India offer IFCS Banking Unit licence (IBU) which is exempted from CRR and SLR requirements.

LOCAL BANKS PUSHED INTO DISADVANTAGED POSITION: It is notable that, due to banks expanding OBU facility, both confirmation cost and financing cost of usance import bills came down significantly over the past few years. OBUs have made it easy to access low-cost financing opportunity for both importers and exporters of the country, which would have otherwise been met by borrowing from banks in local currencies at higher interest rates or through overseas bank's counter. The new local OBU policy will increase the cost of fund for OBU significantly and make local bank's OBU unattractive while overseas banks and lenders will enjoy advantage as they are not subject to these regulations.

Another policy differentiation is when multinational organisations/overseas lenders directly lend to local corporates. In most of the cases these multinational organisations do not pay any taxes. As a result, local bank's OBUs are forced into non-competitive position both from CRR & SLR requirements and higher taxed entities.

CONCLUDING REMARKS: Offshore Banking Operations have played a pivotal role in the economic expansion of the country by arranging low cost financing compared to domestic currency lending. As most of the central banks around the world are cutting interest rate to support their local economies, we may take advantage of the situation by being able to borrow at lower cost while local currency interest rate remains high. In this global context, tightening the policy might be counterproductive and costly. A comprehensive policy would be much appreciated to bring discipline in OBU operations. We should act sooner than later to support the economy and business in this fast changing global economic and  policy environment.

Md. Shaheen Iqbal is Head of Treasury & Financial Institutions, BRAC Bank Limited. 

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