Home Short payment terms Trade credit, a risky game for banks

Trade credit, a risky game for banks

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Trade credit is used for short-term financing of imports for a period of one year normally. Credit is granted by foreign suppliers or lenders. These are in other words called supplier credit or buyer credit. Under supplier credit, foreign suppliers extend credit for the relevant period; they receive payment at the end of their term. On the other hand, foreign lenders make sight payments to suppliers on the basis of buyer credit for which they receive payments at the end of the due date.

In Bangladesh, short-term import financing from external sources is allowed for the import of specific goods such as capital goods, industrial raw materials, etc. The duration is one year maximum. Importers can import under supplier credit or buyer credit. But there is a special equation: importers are not exposed to overseas suppliers or lenders. Rather, the importers’ banks assume all responsibilities, including payment obligations. How they are responsible for transactions is a question. The simple answer is that external parties expose themselves to banks that commit to making payments when due.

Banks issue letters of credit for use with confirmation made by foreign banks as part of supplier credit. After the shipments have been boarded, the suppliers’ banks submit the import invoices to the importers’ banks, which accept the payment due date data. When due, the banks must settle the payments of the value of the invoice that they have accepted. On the other hand, foreign lenders or offshore banking operations of resident banks make payments directly to suppliers on demand based on import bills accepted by banks in Bangladesh. It is a buyer’s credit for which banks establish import letters of credit on terms of use confirmed by other foreign banks. The relevant letters of credit contain terms of payment to suppliers on demand by foreign lenders. Financing is provided by overseas lenders on the basis of acceptance of import bills by resident banks. When due, foreign lenders are paid with the value of the import bill, including interest.

The advantages for transactions with importers are savings on interest charges since the cost of financing in foreign currency is cheaper than that of financing in local currency. Banks, on the other hand, benefit from commission income, acceptance changes and other fees against their exposure. But it’s a risky game if collateral, including the margin for letters of credit, isn’t enough. Importers are also in a risky position when it comes to currency loss. The local currency may depreciate to a large extent, resulting in additional costs when settling debts with banks when due. In this case, no additional benefits other than payments are paid on deferred dates.

There is a weight factor between banks and importers. Exposure by banks is well published with disclosure at all corners. In the event of bank failure, the image of the country is compromised. But the bilateral lending between lenders and borrowers is an internal issue between them. Non-payment issues are referred to arbitration or court for settlement. In this case, the banks are not parties to the games; rather, they are only facilitators to execute transactions according to established formalities.

There are specified characters in supplier and buyer credit. Importers are borrowers, while lenders are either overseas suppliers or foreign financial institutions. But the prevailing system in the Bangladesh market is a derivative of the original product. In the context of buyer credit, letters of credit issued on terms of use are confirmed by foreign banks which bear additional costs. This cost is higher than the acceptance cost charged by resident banks during the tenure. This confirmation is only required for imports under supplier credit from regular suppliers. Confirmation of letters of credit by foreign banks is an additional comfort for foreign lenders who make payments directly to suppliers against import invoices accepted by resident banks.

In the real case of financing under buyer’s credit, importers with the support of their banks arrange financiers for import payments. Importers import goods through sales contracts or letters of credit with the condition of making sight payments. Suppliers ship goods and send documents through their banks to importers’ banks in Bangladesh. Based on the conforming documents, lenders are requested to make payments directly to suppliers. The obligations of the banks, in the case of transactions by means of letters of credit issued at sight, end with the payments to the suppliers by the foreign lenders. For imports under buyer’s credit sales contracts, no payment obligations shall be assumed by the banks, with the exception of transactional services.

The prevailing mechanism for so-called buyer’s credit is apparently profitable from a nominal point of view. But whether the actual cost is higher or not is a question. On the other hand, there is unhealthy competition between resident banks for import transactions. As a result, they take huge exposure on importers with a simple valuation. Failure to pay, if this is the case, leads banks to face real music. Is this the situation exposed behind the super profits of external borrowing by importers? Shouldn’t they come out of being exposed outside? These are different questions that come up in the situation.

Let’s move on to the foreign exchange regulatory framework for access to financing for short-term external imports. The framework stipulates that buyer’s credit with foreign banks and financial institutions is permitted to make specified import payments arranged through designated importers’ banks, within the limit of the rate ceiling. interest. This regulation clearly indicates that foreign lenders will extend import financing to importers, banks will act as arrangers. On the other hand, the country’s offshore banking regulations stipulate that a bank, in its offshore banking operations, can discount invoices accepted by importers’ banks in Bangladesh against deferred/utilization letters of credit. This regulation is a clear instruction for the discounting of import bills by offshore banking. In this context, offshore banking operations must make discounted payments to suppliers abroad and make full payments to the banks of importers who have given their acceptance on the due date. But inside information indicates that the practice is different. Offshore banking does not discount accepted usage bills, but rather makes full value payments to suppliers for which it makes payments from importers’ banks with interest applicable to the buyer’s credit. This procedure is known as financing under letters of credit UPAS. This financing is, besides the offshore banking operation, extended by foreign banks under the UPAS model. The introduction of UPAS letters of credit has phased out normal-use imports under letters of credit, according to inside information.

The model reassures importers since imports on credit from suppliers would be costly compared to sight imports under UPAS financing. But this creates a huge risk exposure by the banks in their balance sheets, resulting in high costs for confirmation services, correspondence services of overseas peer banks. The central bank can assess the risk consumption capacity of banks for transactions according to current practices.

Whatever conclusions are found, the actual buyer’s credit model should be presented on the screen for which importers should be encouraged. In this case, the import of inputs may be allowed for 360 days or for the duration up to the cash farm circle, whichever is lower. General authorization should be given to importers to grant corporate or personal guarantees, make cash assignments, etc., to foreign lenders. These guarantees can help to benefit from the actual buyer credit for which the importers themselves will be required to repay the loans. This can create real markets for lenders to play with competition. Otherwise, they continue to lend in the name of buyer credit by resorting to resident banks. In the long term, the practice of huge risk exposure may prevent our banks from establishing banking relationships with counterparts for different services required in global transactions.

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