RMG: Challenges Faced by Banks

April 25, 2020

Challenges Associated with Promoting RMG Trade by Banks

(Published in the Financial Express in 2018)

Dr. Shah Md Ahsan Habib[1]

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, in Bangladesh, some of the challenges are malpractices related to non-compliance of regulation or guidelines; and some of these are intentional, and many of these are due to knowledge gap. Behavior on the part of clients and their external counter parts are also causing risks for the banks, traders, and the country.

Documentary credit remained the most prominent payment technique in import and export facilitation in RMG in Bangladesh. Documentary collection is extensively in use alongside documentary credit in EPZs. This is sharp contrast to the global practice in general where most payment transactions take place through open account. Of the different types of LC, back-to-back and transferable LC 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 on TBML and shadow banking are additional issues favorable to the use of LC and documentary collection in developing countries like Bangladesh. There is no doubt that the country cannot afford to keep away completely from all the 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 digitization and use of block chain 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 favorable 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 connected with credibility, but also to have right kind of regulatory control to address financial crime like TBML.

There are evidences that in Bangladesh, a good number of trade transactions 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. In several instances in RMG, traders failed to undertake legal actions due to the weaknesses in purchase/sale contracts. Back-to-back against contracts are found to be relatively risky and prone to greater risks as compared to that of against master LC. It is suggested that bank should not enter into contact-based export without satisfying credit worthiness of the exporter and the importer. Credit worthiness of the counterpart and legally enforceable contracts are crucial for RMG traders. Contract Act of the country is not prepared for international trade transactions. Though eighty-nine global countries ratified UN Vienna Convention as the regulatory guideline, Bangladesh is yet to do that. For sound purchase/sale agreement, it is essential to have coverage of a regulatory framework. Alongside ratifying UN Vienna Convention on Contract of Sale, there should be clear instruction on the trading with non-ratifying countries in regard to the guiding framework for all international trade transactions. It is also right time to undertake preparatory work for adopting with on-going global trade digitization movements.

Credit risk and default loan scenario in trade services in Bangladesh is not different from the NPL scenario in the country as a whole and RMG is no different. 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. There are significant instances of discrepancies of documents in RMG LC 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 decay over reliability of documentary credit in the RMG sector of the country. Time has come to have separate LC law for the country. This can be achieved either by enacting separate law like USA, China and 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 counter part is particularly crucial for the traders, however, in several exporters are not ready to obtain that or incur cost on that. The formats of credit reports obtained by different banks and contents are generally different and some seem inadequate. In such a circumstance, Bangladesh Bank 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 has been particularly supportive in materializing 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 causing undue problems to the exporters by not issuing pre-shipment inspective certificate in due time. Earlier buying houses used to obtain licenses 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 of the country. Ministry of Commence of GOB is working to formulate a policy framework for the buying houses.

Incidences of trade based money-laundering is a growing concern for policy makers and central banks throughout the globe and it is affecting RMG trade and service providing bankers. Though the available sets of AML rules are in line with globally accepted standards, still there is lot of scopes to improve their enforcements and identifying the applicable red flags in the context of the country.  Probably the country needs a customized guideline targeting its own TBML issues. Compliance is already the greatest concerns for the banks, and greater compliance requirements are affecting operational costs of trade financing. Reporting system has a role in this connection. Enforcement of online reporting and monitoring system by the Bangladesh Bank have brought positive changes in terms of decline in irregularities by banks and improvement in data accuracy. Since the obligation of ensuring the prices of importable items are ‘competitive’ and the price of exportable item are ‘fair’ lays with banks so, they have to find out an effective mechanism to implement the obligation. Though customs offered a list of minimum prices for selected items for tradable, the problem remained. The country needs greater coordination amongst different stakeholders to address the pricing issues and country risks for competitiveness and regulatory compliance. Greater coordination with customs has already brought positive changes in addressing the challenge. Collective efforts from FEPD and BFIU of BB and custom authority are the prerequisite for greater enforcement of AML rules.

There is no doubt that quality of trade services of the banking industry 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 expertise amongst 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 of capacity development and support on the part of banks, increase in the compliance cost became concerning, and there are apparent instances of cost-saving efforts, and excessing work-load on the executives of trade service departments. Alongside investing on capacity development of the bank executives, awareness initiatives for the RMG traders should get due emphasis to minimize the prevailing risks.

[1] Professor and Director (Training), BIBM ([email protected]).

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