Covid-19 Affecting Trade Financing by Banks

April 20, 2020
finbislesh
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(Published in the Financial Express in 2020)

We have witnessed several predictions, forecasting and warnings of the global reputed entities and bodies on the potential economic impacts of significant slowdown of the global economy following the Covid-19 outbreak in China. However, with the passage of time the situation is getting worse with the emergence of even bigger outbreaks in USA and EU, and thus reasonably forced the globe to wait for much greater devastation in the economic fronts. All major trading partners are already in the intense grip of Covid-19, and facing international trade contractions, commitment failures, cancellations of orders and supply chain uncertainties. Global shipping activities are sharply affected with the cancellation of sailings and upended logistics and are causing immense harm to the trade facilitation as shipping is responsible for nine-tenth of the global trading activities. These serious challenges of international trade transactions are getting translated into the disruption and shrinkage of trade financing activities, one of the key areas of fee and interest incomes of banks throughout the globe.

As the condid-19 disrupts global supply chains, experts are predicting that the trade finance revenues are bound to get hard hit. The worsening situation is getting visible as the pause on trade and production across the globe is taking its toll. Default rates for bank-originated trade finance have historically been low across products and regions, according to the International Chamber of Commerce. However, there are fears that banks may have to face severe loan-default challenge even in trade finance in response to the covid-19 outbreaks.  The increase in trade finance default in the coming months may make the situation miserable for trade financing banks if not tackled rightly. Smaller banks will likely be hit the hardest.

By encouraging banks to offer more trade finance to get the economy back, policy makers started responding and are engaged in injecting fresh liquidity. International institutions and bodies are coming up with supports. The package from the International Finance Corporation is to be spent to help commercial bank clients expand trade finance and working capital lines. Relatively, smaller sized banks of the developing countries might face even greater challenge when faltering demand in the US and EU and disruption in China are resulting unforeseen business environment for them and the other economies.

As in most other global economies, Covid-19 are affecting the real economy, financial transactions, businesses, commerce, and consumers in Bangladesh. Entrepreneurs are facing uncertainties with their investments and financial obligations; and workers are facing the fear of job losses. As a whole, China is the most important boarding partner of the country from where Covid-19 started its journey. USA, Germany, UK, Spain, Japan, Hong Kong are other major trading countries that are already in the huge trouble in Covid-19 battle ground. The country’s RMG sector is now exposed to a much bigger threat since EU and USA, the major export destination of the garments of Bangladesh are at the center of the Covid-19 warfronts.  Due to the rapid outbreak of this deadly virus, governments of the affected countries were forced to introduce self-isolation to complete lockdown of cities. As a result, consumer spending contracted substantially and local stores and malls were forced to shut down, prompting international fashion retailers and apparel brands to cancel their order volumes.  Symptoms are showing that the apparel sector of Bangladesh, the USD 40 billion industry, may suffer badly for the outbreak of the virus. Already exporters of the country are experiencing delays in the shipment of goods. RMG entrepreneurs are experiencing cancellation, postponement or rescheduling of orders and delays in delivery.

Based on the experiences of the crisis (20016-08), in a recently published article by Dr. Sheng from USA, it has been shown that the decrease in GDP and consumption of apparels, China and Bangladesh might be severely affected.  According to the estimation, with the decrease in GDP by 5-10% in EU and USA, the import demand of apparels from Bangladesh may decrease to 7-17% and the associated job cut might be between 4-9%. By the time, more than USD 3 billion worth of orders in Bangladesh’s garment sector has been canceled and new cancellations are coming up, as disclosed by the BGMEA source.  Cancellation of current orders means an imminent threat to the RMG backward linkage industries. These orders, which were placed by the international clothing retailers and buyers some months back, are already produced and made ready for shipment by the local manufactures. Entrepreneurs have already incurred costs and remain indebted to all other suppliers from whom they have sourced the raw materials. These cancellations are causing obstruction in their scheduled wages and may even lead to the termination from jobs if production discontinued for long. Especially, the situation is dire for the smaller companies of the industry. In addition, a significant portion of capital machinery and spare parts for the textile and garment industry come from China. Some factories are already struggling to run properly. Moreover, other sectors like computers and electronics, heavy machinery, shipping, transport, tourism and development project funding are expected to get negative impact soon.

The trade financing industry of the country, the banks, is already started facing challenges with the trade disruption. Cancellation of order is having and will have notable negative consequences of the back-to-back obligations of banks. A significant of these back-to-back might be opened against ‘purchase/sale contract’ as happens normally. Cancellation of contracts imposes little obligation on the potential importers of garments from the country, as many of these are not legally enforceable. For a number of clients raw material are already in the country against back-to-back, some are on the way, and for some back-to-back has already been opened. These are creating or will be causing huge uncertainties to the banks. Situation is resulting uncertainties and payment challenges for the exporters and thus for the backward linkages industries. Ultimately these may cause non-performing assets on the part of banks. Importers are facing difficulties as some are not in a position to release the goods or to sale their importable to payback payment obligation of banks. It is true that a good section of traders are facing difficulties and BB’s initiatives related to the relaxation of loan classification norms are logical support for them. These are due support for banks as well till June 30, 2020. However, banks challenges might be long lasting if bad borrowers take advantage of the situation. To support exporters, as expected, the central bank offered due extended time for realizing export proceeds, submission of import bills of entry, back-to-back letter of credits and payment of export development fund loans etc. Refinancing package for pre-shipment credit and lowering interest rate of EDF are reasonably good support for the exporters. However, for certain scenarios like back-to-back, foreign counterparty of the exporter must agree with the extended time, otherwise that will create additional payment obligation for banks. Unlike global trends, low default rate for bank-originated trade finance is not relevant for Bangladesh, rather actual non-performing loans in trade financing are at par with the other forms of classified loans. Banks of Bangladesh, which are already battling with an issue of high non-performing assets, might be struggling in the wake of the pandemic.

Payment obligations of banks and traders in case of letter of credit (LC) are confronting challenges of commitment failures and uncertainties. There might be tendencies of giving spurious discrepancies to scape payment obligations by banks in a situation when bankers are shaky and banks are facing liquidity problems. As one of the major users of LC, banks of the country are also expected to go through the situation. With the export disruption, inflow of export proceeds are getting affected which might affect the supply of USD in the market. In addition, it is evidenced that the remittance sector, registered robust growth in recent time, may see sudden halt.  It can be noted that some of the countries severely affected by the coronavirus are those where many Bangladeshi citizens live and work and these facing the dual challenges of the pandemic and the falling oil prices. Thus, with the export and remittance related uncertainties, shortage of USD, an additional challenge of trade financing activities by bank to make payment obligation, may need to be addressed in near future.

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