Trade Finance Article

Primadollar transactions in absence of factoring

30 November,2018

The cost of finance drives buyer and seller decisions in international trade. New solutions are sorting out ancient problems in this area.

In international trade, both buyers and sellers are concerned with the completion of a deal. The buyer wants to be sure that he receives the goods of the quantity and quality agreed. On the other hand, the seller is eager to receive payments on time and in the currency required once seller has sent the goods.

This article was originally published in The Asian Age.

In order to meet these demands, various methods of payment have been developed. There is another more important factor is the cost of money. The cost of finance is not simply the rate that is charged - it is also the restricted availability. Exporters in Bangladesh has crisis of working capital like any other developing economies.

The policy of government and Central Bank is very clearly mandated for all out financial support for working capital. Exporter has experience of local banks asking for collateral for back to back LC for raw materials and other working capital against master export LC. FIs hardly consider good will of the company and insist on collaterals for each categories of credit. The collateral based credit policy is a weakness of banking system.

But this story plays from the other side as well - of course, finance is also limited for buyers, and, believe it or not, it is also limited for Western FIs. Importers very often request for deferred payments of their import Lc/ contracts. The trade finance remains stubbornly an issue for everyone - creating an unwelcome frictional cost in the bargains that rational companies want to make.

The situation seems in gridlock of orthodox financial policy for garments which, contributes 80% of the total export. Historically the working capital of both exporters and importers also another challenge, since the garment trade require more working capital than any other business due to longer lead time of every deal. 

Another factor is at play on deciding the investment of FIs. First: after many years of discussion, new regulations (Basel 3) are now in force across international markets. One requirement is that banks maintain a leverage ratio. This is the ratio between their core equity and their total balance sheet. A high financial leverage ratio means that the company is using debt and other liabilities to finance its assets -- and, everything else being equal, is more risky than a company with lower leverage.

FIs in other countries now prefer to work with contract than L/c. The new finance product "Factoring" now reduces the leverage of bank since the risk are taken over by the Factoring companies. FIs in Bangladesh now can earn quick return and easy return on their investment on international transaction through L/c. This is because of the old fashioned financial sector. But unlike Bangladesh, the western banks have different market. The Letter of Credit or other trade finance occupies a lot of balance sheet, but delivers only a low return for the provider.

Consequently, LC is falling out of favor - as banks would rather use their balance sheet capacity, as restricted by the leverage ratio for
higher margin activities.

From the sellers and buyers perspective of terms of payment is now an issue to concern. There are basically four methods of making payment for international transactions. These are

i) cash in advance

ii) open account

iii) documentary collection and

iv) documentary credit.

There is a solution to the payment terms, crisis of fund and reduction of cost of transactions through different types of trade financing for both exporter in developing country and importer in developed country. The buyers are forced to adjust the price with cost of products on the basis of payment terms. Some time, the additional cost of transaction with L/c that the exporters and the importers are shared between them. These either case the burden of cost has impact on sourcing of products. But alternately buyers prefer open account basis without Lc and also factoring of transactions to reduce
cost and time of transactions.

For Bangladesh, this is important to understand. Historically, exporters could rely upon buyers offering them an LC as financial support, which could be used for back-to-back finance in the local market. Buyers were happy to do this - LC's been not that expensive to organize - banks were willing to provide. Exporters could obtain working capital loan against exporter L/c against further collateral security. Bangladesh exporters offering lower prices but same time even better quality than
competitors until recent time.

But the situation has gradually changes. As credit from local banks and LC becomes scarcer, buyers become reluctant to provide LC. This is driving them into the hands of Indian, Vietnamese and even Chinese factories who are better capitalized than typical Bangladeshi manufacturers - and who can work without LC and offer open account and delayed payment.

There are some finance companies came with new product the "Factoring". This is a new finance for Bangladesh. It is a hybrid between factoring, which is quite new in Bangladesh and the sellers and FIs are trying to understand. It is an agreement between an exporter and factor whereby the factor purchases the trade debt from the exporter and provides the services such as finance, maintenance of sales ledger, collection of debts, and protection against credit risks.

There are various forms of international factoring. It may be simply defined, it as a purchase of receivables by factor from its client and collect it during the maturity from the debtor. Usually the
factor pays the client about 80% of the value of the receivable and remaining is paid by collecting from the debtor after the deduction of charges. There are few categories such as (1) Bulk Factoring,
(b) Maturity factoring, (c) Agency Factoring, (d) Invoice discounting etc. Factoring is flexible form of finance and with the help of factoring it is very easy to predict the cash flows. The factors immediately finance up to a certain percentage of the eligible export receivables.

The buyers now asking for export against contact or open account and the payment supported factors. Bangladesh can use this new financing product and work with good quality buyers around the world on equal terms with the Chinese and the Indians. Equal terms means that the buyer is simply not troubled by the financing required in order to bridge the time from "order to cash". The letter of credit also involved addition demand for margin deposit for L/c. The buyer can get deferred payment facility without any additional collateral.

This is good news for the buyer - because his scarce credit resources are used for his own purposes. This is good news for the buyer's bank, which can refocus his credit supply onto higher margin lending and services, and away from low margin trade finance. Bangladesh need a legal and policy support from Central Bank for factoring of international deal. The local banks can support their exporter client with back-to-back Lc for raw materials if Central Bank gives policy support for back-to-back Lc against contract.

Factor Company is a new breed of finance company that can level the playing field for Bangladeshi factories - and allow them to trade with buyers on open account with delay of payment and without LC. In South Asia factoring services has come up in 1990 after its successful launching in India and Sri Lanka. Bangladesh exporter can bargain better payment terms like deferred payment, export against contact (open account) or factoring etc. Western buyers are ready to pay more for better and less expensive payment terms. Exporters can now offer the same deal to the buyer that their stronger international competitors can. Bangladesh can compete with other competitors with better finance and better business terms with acceptance of factoring and innovative financing of trade.

Bangladesh Bank is working on Factoring and a policy paper has been prepared by a team of experts under leadership of Professor Proshanta K. Banerjee of BIBM. The export policy order 2015-18 also has mention of new transaction facility through "Factoring" to promote export. These actions are indication of positive direction for introducing Factoring in export finance in Bangladesh. Now she needs a law and/or a binding rule to cover the transaction under this new banking product. 

There are already international non-bank financial institutions in the Bangladesh namely Primadollar from UK. They have now developed a new international trade finance product suitable this market in absence of legal and policy support for Factoring. There will be more players in the market Primadollar type finance products to facilitate export finance. These new entrants are filling a gap that is created by the shifting rules of international finance and easy transaction without any other risk of exporters and local and overseas FIs as well as buyers in other countries. 

The writer is a legal economist. Email: shah@banglachemcial.com

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