Dr. Shah Md Ahsan Habib
International trade financing and the associated services are getting reshaped or we are observing newer efforts on the part of regulators, banks, traders, and other stakeholders to give trade financing a renewed impetus in the context of the Covid-19 situation. For consolidating and supporting trade services in this complex situation, Bangladesh Bank has issued a good number of circulars. Of these, a circular issued on June 30, 2020, with the title ‘Export under open account credit terms against payment undertaking/payment risk coverage with option of early payment arrangement on non-recourse basis’ is a notable one that appears to be an approach towards the direction of adopting evolving trade finance products in the global market. This is a dynamic approach on the part of the central bank of Bangladesh.
About the term ‘Open Account’ in the circular, it is not the ‘open account’ in its pure form. We are aware that ‘open account’ means shipment and delivery of good before payment is due where the exporter is at risk. Whenever we conceptualize ‘open account’, it is also to be characterized by less involvement of banks in the process; greater involvement of the traders; relatively cheap; and is guided by the purchase/sale contract. Practically, on these considerations, the Bangladesh Bank’s circular is not about that form of ‘open account’. Rather it is a form of ‘conditional open account’ that has essentially taken care of the key issues like the exporters’ risks and the country risk. Practically, other than the ‘cash in advance’, all globally popular methods are some forms of open account. Considering the existing trade service practices, the capabilities of the traders and the associated country risks, the central bank’s approach seems to be right.
We know that trade financing products are commonly categorized into ‘traditional trade financing products’ like letter of credit, documentary collection, standby LC and international bank guarantees; and supply-chain products that mainly include, receivable finance, payable finance, loan against receivables, factoring, forfaiting etc. These financing products are generally appended with trade payment methods. Open Account is the most commonly used method of payment. Data on the exact volume of trade financing products lack accuracy however still, traditional trade financing products have comprehensive dominance in the market. In considerable instances, international trades are facilitated by trade services of banks and financial institutions covering documentary credit (LC), documentary collection, standby LC or international bank guarantees. Supply chain products, most of which are associated with the open account transactions, are finding grounds in recent years. Bangladesh Bank’s circular essentially includes both the traditional and supply chain trade products. The circular has offered scope to serve traders using both traditional and supply chain products combining with the open account transactions.
It is to be noted that the use of commercial letter of credit in the context of Bangladesh and the Asia-pacific regions should not be considered only from the perspective of facilitating payment and financing. The product has unique features of handling country and crime risks, and a balanced approach of risk-sharing between exporters and importers. The classic and universal acceptance of its guiding framework i.e. UCPDC is its huge strength. Thus, despite the limitations of its lengthy, cumbersome, and costly processes, it has been dominating as the most widely used trade financing product in international trade transactions for long. Sometimes, we wrongly compare ‘letter of credit’ with ‘open account’!!! Open account is simply a fund transfer process and generally not considered as a trade service product. Practically in a sense, trade transaction means open account, and both the traditional and supply chain products may be used to minimize liquidity gap and to handle the risks associated with the open account transactions.
Supply chain products are relatively recent developments and risk mitigation techniques. Supply chain finance is said to be responsible for the majority of trade finance market growth today. The ICC Global Survey, however, reveals a clear divide in how trade banks are planning to engage with supply chain finance. The survey found that 64% of global banks already offer a supply chain platform whereas just 38% of regional banks, and 13% of local banks are engaged with it. In terms of the different supply chain products, receivables discounting (71%) is seen as the most in-demand supply chain technique from a client perspective, followed by payables finance (54%), loans/ advances against receivables (46%), and factoring (45%). While not necessarily evident from the survey data, there is substantial variation in the customer profiles of these different products. Historically, receivables financing and factoring have been skewed to the micro, small, and medium enterprises (MSME) market, with payables financing more commonly used by larger corporates. According to the most recent ICC survey, the current market patterns are starting to change with increased demand for receivables finance among lower-margin and high-revenue large corporates, as means to manage cash flow and liquidity.
Regarding the product composition in the market, the composition is changing. As per the most recent ICC survey, majority of the respondents (52%) indicate that supply chain constitute only 0-5% of their trade finance made available today, however, there are evidences that the popularity of the supply chain product is growing amongst the traders. About 35% respondents believe that the proportion of their supply chain finance would be 0-15% in 2025; where as 38% have expectations that there figures would be somewhere 15-30% of the total trade finance; and 10% have expectations that their supply chain finance would cross 50% of the total by 2025. Thus, despite possible changes, the data indicate the visible dominance of traditional trade financing products in the foreseeable future. And of the traditional trade financing products, Standby LC is getting popularity even in the commercial trading activities.
It is true that the ‘supply chain financing’ received focus mainly following the challenges associated with trade services during 2006-08 crisis, and the ongoing crisis has further highlighted the issue. However, it is also true that demand for traditional trade financing product like commercial letter of credit increase following crisis at least temporarily. ICC survey remarked, in the context of Covid-19, products like letters of credit and bank guarantees will likely to grow in popularity given their reputation for risk mitigation; and thus we may expect a temporary shift toward documentary trade.
Probably, the most critical force that is going to contribute for reshaping the trade financing industry is the ‘technology’. Several stakeholders are already engaged or are getting ready to modernize to enable more digitized trade. Time has come when, documentation should no longer be mandated to be paper-based in the context of trade financing. The digitization is expected to change the process, transaction patterns, and costs of both traditional and supply chain products.
Bangladesh Bank’s circular on ‘conditional open account transactions’ is a good initiative, which means the products may be used. However, it is the traders who should consider cost, necessity, and risks before choosing one. Bankers must also calculate and disclose all the relevant information related to cost, legal obligations, and compliance issues to their clients to ensure the suitability of a product for a particular client. Especially, country and compliance risk issues should get the utmost priority to the ‘authorized dealers banking institutions’ of the country in facilitating a particular type of trade services. In the context of Bangladesh, using letter of credit is about handling a number of risks at the same time. The newest addition probably is the risks associated with the trade-based money laundering where LC and traditional trade financing techniques have proven credibility. ‘Pool of LC Specialist Bankers’ is an added strength of using LC in the country. Of the traditional financing products, Standby LC has also great potentials in the country. We cannot also keep ourselves away from the supply chain products. Digitization of international trade financing is probably the most important agenda ahead. However, for optimum benefits, it is also crucial at this moment to ratify globally accepted conventions and regulations for ensuring the enforceability of purchase/sale contacts.
[1] Professor and Director (Training), BIBM ([email protected]).
