Banking system mainly provides all types of transactional services including trade transactions. However, banks themselves are not exposed in all cases.
Direct exposure by banks is found with the invention of back to back letters of credit (LCs). This new type of LCs is the by-product of readymade garment industries. Garment industries are allowed to open LCs for procurement from backward linkage industries such as textile mills, spinning mills, accessories factories, etc. The payment is settled by export proceeds in foreign currency. In addition to back to back LCs, banks can settle payments in foreign currency for transactions allowed by central bank.
Business transactions are basically bilateral in nature. Buyers and sellers agree upon themselves as per contracts. They should finalize the deals based on the underlying contracts. Despite sales contracts, they rarely settle the deals by themselves. Rather banks become facilitators and stand between sellers and buyers. The instrument works to facilitate the transactions is known as LC. Under the system, banks make conditional commitments to beneficiaries to make payments on behalf of buyers. LC is a contract per se. Underlying arrangements between buyers and sellers are also contracts. Despite they are not comfortable, rather prefer LCs. It indicates that bilateral arrangements are embedded with bottlenecks. Enforcement seems to be cumbersome in case of non-performance or default in payments situation. LC is a better option both for sellers and buyers comparatively.
Back to back LC is a household name in readymade garment sector. The sector is said to be flourished with the support of different policies. Back to back LC is one of them. To facilitate promotion of backward linkage industries, back to back LCs are allowed for inland transactions to supply intermediate inputs to exporters producing outputs for exports. The transactions are settled by buyers out of export proceeds they receive from abroad. Local suppliers are treated as deemed exporters since they supply inputs contents in exchange of foreign currency. Export trade of the Bangladesh is reported at around 50 billion US dollar in a year. Of the total exports, around 30 billion US dollar is used for import payments as per business insiders. These payments are of two types - imports by direct exporters and by deemed exporters. Imports by deemed exporters include basic items like cotton, fibers, and other items. Inland trade is reported to be nearly 20 billion US dollar in a year. If it is true, Bangladesh is in progress to achieve high value addition out of its export trade. This is a success story, indeed.
Behind the success story, banking system played a role. It is said that necessity is the mother of invention. Back to back LC is an easy way of financing for readymade garment industries. It is basically issued against export orders. It means that banks open back to back LCs to finance te procurement of inputs contents by industries keeping export orders as collaterals, among others. But back to back LCs cannot support to backward linkage industries in the same way as they do in case of direct exports. Back to back imports mean case to case imports for producing outputs for specific orders. Such back to back imports are not fit for retail sales. They need imports in bulk quantities. Such imports need huge working capital supports. There needs financing in foreign currency. Financing is not always adequate considering the liquidity in foreign currency in domestic market. Within the regulatory framework, supplier's credit is of support. It means that foreign suppliers provide goods on credit. It is a solution but it is not cost effective. Price is higher compared to cash purchase.
Foreign exchange market of the country faces higher demand compared to supply. Considering market liquidity, settlements at cash payments are possible provided that external credit line is available. With the focus on readymade garment industries, Bangladesh is well known in global financial market. Banking system of the country is well connected with global banks under counterparty limit. For cost effective imports, another invention is found in place. Import on credit under letter of credit is turned into import at cash. How it is possible is a question. But it happened. Bangladeshi banks started arranging financing of deferred payment terms LC through other banks outside Bangladesh. The program is supported by the policy framework from central bank. Later the facilities became widely available by offshore banking services of local banks. The product is, like back to back LCs, a household item in banking system as UPAS (usance payment at sight) LC.
“Banking system plays a crucial role in facilitating inland trade,
particularly through instruments like back-to-back letters of credit
(LCs), which support the readymade garment sector. However, challenges
remain, including liquidity issues and complex formalities in LC
processes. To address these, the central bank has issued directives to
simplify domestic trade transactions and introduce electronic platforms
for smoother operations. This initiative aims to improve efficiency and
ensure timely payment settlements, benefiting both exporters and
domestic suppliers.”
Banking activities are run by banker-customer relationship. If there is no relationship, service is not available from banks. It means that the deeper is the relation, the better is the service. Depending on the size of business, banks extend their hands. Hence, small valued customers are rarely to expect better facilities from the system. This is the reality. Same is true for marginal customers. With regards to inland transactions, local suppliers make delivery of goods under back to back LCs. This delivery is a part of total exports. As such, both direct exporters and deemed exporters are not even. They are not treated evenly. Is it true? As discussed above, small customers are not treated well whatever regulations or theories state. It is completely dependent on relationship between banks and customers. Banks will not focus on customers giving subsistent revenue. In this situation, market regulators try to equalize the situation through different guidelines.
In very recent time, central bank issued a directive which is related to back to back LCs. In the directive, it is stated that permissible domestic trade in foreign currencies faces bottlenecks due to various clauses embedded in LCs. These clauses are often difficult to be met within the validity of LCs. As examples, the directive said that LCs require delivery challans to be signed by top officials of LC applicants, documents needs to be accepted by applicants before these are submitted to beneficiaries' banks. These very two examples indicate how domestic suppliers are treated. LCs have specified time. But the exemplified points cannot make suppliers able to complete the formalities within the validity. The directive expressed concerns by saying that domestic sellers frequently encounter financial difficulties due to prolonged processing time. As a result, domestic trade activities, including financing by banks, remain sluggish and lack vibrancy, as per the directive.
Through the directive, central bank asked all banks to establish operational modalities that can simplify domestic trade transactions in foreign currencies. LC issuing banks need to avoid incorporating conditions in LCs which cannot be maintained during the validity of respective LCs. On receipt of documents for payment/acceptance, banks shall conduct usual formalities for examining them, and making payments or acceptance, whichever is required; in no way, banks cannot forward the documents to LC applicants for examination and their acceptance.
As per the directive, transactional framework for inland trade needs to be brought under electronic platform. Accordingly, banks should introduce electronic options with regard to communication relating to LCs such as transmission, advising, presentation, acceptances and all subsequent communication under mutually agreed systems with counterparts. In case of electronic options, banks shall have safe and secure electronic systems, compliant with the Guideline on ICT Security in force.
The initiative by central bank deserves felicitation. This can bring discipline in inland trade through introduction of electronic movement of documents and timely settlement of payments. This can ensure smooth financing by banks based on accepted documents. Banks should adhere to regulations and effective supervision needs to be activated by central bank for the adherence.
The writer is a teacher
