Data Gathering and Stringent Reporting Requirement Help Effective Monitoring of Short term Foreign Currency Financing
(Published in the Financial Express in 2018)
Dr. Shah Md Ahsan Habib
In the process of import financing, documentary credit is one of the key form of foreign currency off balance sheet financing by banks in Bangladesh. As LC is the most popular form of trade payment method in the country, banks are required to commit to make payment in foreign currency to the foreign exporters on behalf of the importers and thus undertake off balance sheet foreign currency liabilities subject to compliance of documentary conditions. Risk of LC obligation arises if importer fails to meet commitment to the issuing bank. There are several instances when issuing banks faced NPL due to failure on the part of importer though the banks were to comply with the foreign currency commitment to the foreign exporters. LC has been in use in Bangladesh to facilitate pre-shipment credit to the exporters with the title ‘Back-to-Back LC’. Back-to-Back LC is a financing arrangement between bank and exporter common in the country to import raw materials for preparing exportable. The technique is very common in Bangladesh. It is a risky financing venture by the Issuing bank where loan account adjustment depends upon credibility of not only of the exporter (who is availing back-to-back facilities), but also of the importer of final exportable.
Buyers’ Credit for Deferred Import LC payment or UPAS has become one of the core financing instruments under short term financing products in the country. Practically, UPAS started practicing in our country from early 2008 where these types of LC issuance were very limited by the offshore for the big corporate of our country (though there was no specific reference of UPAS/buyers’ credit in the guideline). Following policy changes with specific permission for UPAS/buyers’ credit, the use of UPAS expanded. However, it is mentionable that although OBUs has increased capacity to accommodate UPAS transactions, major exposure is still lying in foreign books. Practically, the major lending function as a part of core banking activities are basically captured by the OBUs belonging to foreign banks due to availability of low cost fund and global network. Banks render UPAS credit facilities to its valued customer in two ways: One, UPAS credit service through own offshore banking Unit (OBU); two, UPAS credit service through overseas Correspondent Bank. Starting in 2013, the volume increased to over USD 5000 million by the end of 2016. There are also tendencies of default on the part of the client that are reflected in the overdue figures of ADs payable to OBUs.
Benefits of buyers’ credit are clearly visible in the opinions of banks. Buyers’ credit or UPAS are allowed for five broad categories of items-industrial raw materials for own use; capital machineries for own use; costal vessel including oil tanker and ocean going vessels; agricultural implements and chemical fertilizers; and lifesaving drugs. There are also tendencies to shift from opening of sight LC to usance LC to take advantage of the low interest of UPAS which may result growing foreign exchange exposure on the part of issuing banks. There are also allegation of taking undue advantage by some traders in the absence of clear definitions of raw materials and capital machineries and undue performance of enforcement agencies. Asset liability mismatch is the key challenge of UPAS facilities. Other than borrowing from multilateral financing institutions, in several instances, OBUs are borrowing in the relatively shorter run to finance relatively longer run financing activities. Moreover, in some instances cancellation of the renewal of long term loans by multilateral agencies caused huge challenge to some OBUs.
In Bangladesh exporters can use export bill discounting in foreign currency for usance export bills against direct and deemed exports of products produced. Several challenges and risks might be associated with export bill discounting. The key challenges include difficulty in risk of timely repayment of drawee bank or importer, fund management, risk of fund diversion, exchange rate risk etc. As per the requirement, beneficiaries of usance export bills against direct and deemed exports of products produced in Bangladesh may arrange to discount bills for immediate financing through their own authorized dealer banks for future import payments including back to back liabilities. There are instances that foreign currency received from Export Bill Discounting is converted to BDT for meeting up local expenses rather settlement of other import liability. Misuse of export bill discounting may cause greater exposure in foreign currency.
Sudden growth of private sector credit is clearly visible following the year 2013; and there are adequate evidences that point towards sudden growth of banking sector’s foreign currency liabilities following the initiation of buyers’ credit or UPAS activities in the country. It is crucial now to continuously monitor the trends and growths of the short term foreign currency liabilities of banks. And for that the first step should be to gather or summarize short term private credits of the banking sector. OBUs are required to come under BB’s scanner for effective monitoring of the foreign currency financing including that of UPAS activities.
There are evidences that OBUs of the country are using foreign sources extensively to finance UPAS, export bill discounting, and offer credit to the industrial units in EPZs. There are also indications that OBUs are increasingly coming across asset-liability challenges in the process of borrowing from external sources and financing internal activities. OBUs of the local banks’ liability sides are dominated by foreign currency loans from multilateral financing institutions and foreign banks; whereas OBUs of the foreign banks heavily rely on their headquarters to meet the funding need. Borrowing concentration from a single country (like Dubai) might cause concentration risk for some banks.
The existing macro picture of short term foreign currency borrowing by the private sector is not alarming by any indicator. The country is also having adequate capacity in terms of ability to pay as indicated by the ratio of short term private credit to reserves. However, given the global experiences with short term financing, a close monitoring and effective management of short-term debt (in particular, of that intermediated by domestic banks) are essential to avoid any future difficulty. As long term borrowing creates short term obligation of making repayment as well, these should also be considered while estimating short-term liabilities of the banking industry. Banks are also undertaking foreign currency liabilities in the form of offering guarantees in most of such long-term corporate borrowings. To ensure effective monitoring, there should be sufficient information to allow policymakers to assess the extent and impact of short term foreign currency borrowings and to devise appropriate policy responses as needed. Moreover, activities of OBUs are required to be under scanner on the way to address trade based money laundering in the context of the country. Existing reporting arrangement does not seem to be sufficient to facilitate these.
It is evident that policy makers and market participants are serious about addressing risks when the sector is at distress. In the global context, it is the time of boom and prosperity of the banking and financial sector when risk issues should get due emphasis of the policy makers and practitioners to prevent any future debacle. It is obvious that no macro indicator shows or forecast any alarming sign to any financial debacle in the context of the country, however, the global developments appear to demonstrate a pre-debacle boom environment; and the country should ensure strong footing to avert any future spillover of that, if any.
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