Short Term Foreign Currency Financing by Banks: Bangladesh Case
(Published in the Financial Express in 2018)
Dr. Shah Md Ahsan Habib
Today, global and local banks support international trade through a wide range of short term products both in local and foreign currency that help their customers manage their international payments and associated risks, and provide needed working capital. Bank-intermediated trade finance are typically of short term nature that are used when financing is required by buyers and sellers or exporters and importers to assist them with the trade cycle funding gap. Traders may also choose to use trade finance instruments as a form of risk mitigation. Though trade services units of banks and offshore banking units (OBUs) of the banking sectors of the developed countries are generally free to undertake foreign currency financing activities to support cross border trade, the scenario of developing countries are somewhat different. Trade services activities by banks in foreign currencies are generally restricted and monitored in developing countries. However, not different from developed countries, foreign currency activities of offshore banking units of the banking industries are considered as a separate segment and remained much less regulated in developing countries as well. In several instances, offshore banking entities of a number of developing countries are becoming increasingly engaged in facilitating trade financing directly or through trade services departments/units of banks. The developments brought notable benefits in trade facilitation alongside concerns both at operational and policy perspectives. The write-up is an attempt to examine prospects and risks associated with the short term foreign currency financing activities by banks in Bangladesh.
Foreign currency borrowings have their own advantages and disadvantages; and foreign currency financing can be internally and externally sourced. It provides borrowers access to financial capital to fund investment; increases financial globalization and improves investment scenario. This contributes a lot if domestic saving is low, where the benefits of investment are manifold. It might be connected with national income, GDP per capita and productivity of labour, and facilitates welfare as well. Short term foreign currency financing are connected with supporting trade financing, working capital needs of corporates and foreign currency liabilities by banks. Trade finance or loans tied directly to international trade transactions -make an important contribution to development. These services are perhaps even more important for international than domestic trade, because lack of familiarity with foreign firms and legal systems tends to raise the risk of international trade. Traded goods stand as security for banks and other firms, thus enabling less creditworthy and poorer countries to expand their access to international loans. Banks are more willing to lend when traded goods are available as security. Suppliers and customers are more willing to extend credit to firms with which they have a commercial relationship, because the information gained through commercial interactions is useful in evaluating creditworthiness.
In the context of trade financing in foreign currency, there are growing tendency in several countries to take advantage of the low interest rate structure in developed countries by borrowing in foreign currencies. Historical evidences reveal that alongside benefits and prospects, there are challenges as well. Rapid growth in short-term bank debt to developing countries in the 1990s was associated with some significant benefits, such as the financing of growing trade, but this growth was also associated with cyclical influences, leading to riskier accumulation of high levels of short-term borrowing. Available published literature clearly identified the pro-cyclical behavior of short-term debt to economic shocks that aggravate rather than support adjustment. Excessive levels of short-term debt relative to liquid international reserves raised the vulnerability of countries to liquidity crises and were a major factor in a number of banking and financial crises in 1990s. Even the studies published in recent time almost consistently shown concerns on international investors’ growing preference of risky assets in the form of foreign currency-denominated debts in the private sector of emerging financial markets.
Growth of short terms foreign currency financing is a relatively new phenomenon in the context of the banking industry of Bangladesh. Foreign currency lending-borrowing was concentrated into export processing zones by the OBUs of the country. It was basically the off balance sheet funding in the form of issuing commercial LC – the key nature of foreign currency obligation on the part of banks till 2010, when short term foreign currency financing was allowed by the OBUs of the country to discount bills accepted by Authorized Dealers (ADs) against deferred import LCs. And following the permission of buyers’ credit activities or Usance Pay at Sight (UPAS) LCs, the volume of short term credit growth shown tremendous mark since the year 2012. Moreover, recent increase in long-term foreign currency borrowings by the corporates is offering additional short term and long-term obligations to the banking industry. There is no doubt that these financing activities have brought tremendous benefits for the traders, and there are growing tendencies amongst traders to rely on these products to avail relatively lower interest rate applicable for such foreign currency financing with the support of OBUs. The development demands continuous monitoring to avoid any unforeseen risks.
Long term foreign currency loans may have short term implications. Obtaining long term foreign loan in Bangladesh is a relatively recent development. The main reasons for the private sector to seek foreign loan is the interest rate differentials between foreign currency-denominated (international) borrowing and taka-denominated borrowing from domestic banks. Despite, this enhanced stability of the exchange rate of Taka against the US dollar in recent years is another reason for the demand. All other long term foreign loans (including supplier’s credits, financial loans from institutions or individuals and debt issues in capital markets abroad) must be approved by the Bangladesh Investment Development Authority. The international bank guarantee needs to cover full amount of foreign loan and repayment period. The repayment installments for the long term loan include monthly, quarterly, semi-annual and annual basis. Normally there is provision of grace period for 6 months or one year. Thus, long term foreign currency loans also creating short term liabilities of banks.
The country’s OBUs generally borrow from foreign banks, multilateral development/financing organizations and domestic treasury units (own or others) to facilitate foreign currency financing. OBUs of local banks heavily rely on foreign sources to undertake financing activities, and its key asset is UPAS. For a few instances, OBUs of some local banks are also lending to their foreign subsidiaries. Published data on two key OBU market share holders-foreign banks indicate that their liability side is dominated by borrowing from headquarters and foreign currency deposits; and their asset side is dominated by UPAS and long term financing to the Type A industry and corporate clients.