Methods of payment and financing techniques
In export trade, one may come across a number of modes of payment and financing techniques. The objective of this chapter is to illustrate all these payment and financing techniques which are available in Bangladesh. First, because loans serve to make payments.
More specifically, short-term credit serves to pay for the goods and services needed to run a business. For the purposes of this guide, goods are understood to mean the raw materials and consumables used in production, or products for trading (exports, for instance).
Secondly, the method of payment determines the type of finance one can or should obtain from a lender. This is why, when one approaches a lender for finance, it is important for both the borrower and the lender to know what the funds are for. The subject of how to approach lenders is dealt with in detail in chapter 4. It is useful to describe here briefly the most commonly used methods of payment and the types of short-term credit facilities best suited for each method. However, it is advisable to discuss this with your banker, who may recommend an approach better suited to the particular circumstances of Bangladesh banking system or your business. In this chapter payment methods in export trade are described, followed by financing techniques and other facilities available for exporters in Bangladesh.
- Payment Methods
In import and export transactions, sellers and buyers do not necessarily know each other and are taking many more risks than in domestic trade. How can sellers ensure that they will be paid? Should the currency in which they will be paid drop against their own currency, how can they make certain that this drop will not eat into their profit margins? How do buyers ensure that they will obtain delivery of the goods they have ordered, on time and in accordance with specifications? Unless buyers and sellers know and trust each other they will need to resort to trade payment and financing mechanisms through third parties such as banks or specialized financial institutions.
In the sections that follow, the most frequently used payment methods for international trade are explained briefly, together with the various financing techniques that can be employed. The sort of questions you will be asking yourself, when deciding which payment method and corresponding financing technique to choose, are:
If you are the seller:
What is the risk of my not getting paid? Do I know the buyers well? Can I trust them? Are they financially solid, or are they likely to default?
Do I really need to give them credit? For how long?
How do I manage if I do not get paid right away?
What if the dollar (or franc or other currency) drops in value by the time I am paid?
The transaction looks very profitable but I do not have the funds to buy the raw materials and pay production costs. Who do I turn to for credit?
If you are the buyer:
Will my suppliers deliver? What if the goods arrive late, or are substandard, or do not arrive at all?
Will my suppliers give me three or even six months’ credit? Can I pay them for their raw materials after I have produced my goods and exported them?
What if my currency devalues and I find that the goods I have to pay for have become too expensive?
If you are the seller, it helps to put yourself in the buyer’s shoes, and vice versa. The best transactions are those that satisfy both parties because they lead to further business.
Various means of payments are being used for receiving export proceeds by our exporters. These are: cash in advance, open account, documentary collection and documentary credit. Among these, documentary credit and documentary collections have been observed to be used mostly by our existing exporters. From the point of view of an exporter (relatively new exporter), the advantages, disadvantages and procedures of each of the payment methods have been discussed in the sections that follow.
1. Cash in Advance
In this method of payment, the buyer places the funds at the disposal of the seller (exporter) prior to the shipment of goods. If you are unsure about the buyer’s credit or there are other circumstances which cast doubt on the certainty of getting paid, the last resort is to ask for cash in advance. This may be acceptable to a first-time buyer who trusts you to deliver the goods. In the long run, however, it may not be competitive and buyers will not want to continue importing your goods if they can turn to other suppliers offering better terms.
On the other hand, your buyers may also be a source of credit if they understand that your lack of funds prevents you from supplying them with the goods they need. Obviously, there will have to be some solid basis of trust for the transaction. The buyers may require you to offer them more competitive prices. They may also disburse the funds direct to your suppliers rather than to you. But it is useful to remember that you can turn to sources other than financial institutions if you need working capital to complete an export order.
Since this method of payment is expensive and contains a lot of risks on the part of the buyer (because they have no assurance that what they contracted for will be supplied and received inappropriate manner), they may not be willing to accept such terms of payments.
Thus it is rarely used in Bangladesh.
2. Open Account System
At the other end orthe range of payment methods is the open account system. This is an arrangement between the buyer and seller whereby the goods are manufactured and delivered before payment is required. Open account provides for payment at some stated specific future date and without requiring the buyer to issue any negotiable instrument evidencing his legal commitment. The seller must have absolute trust that he will be paid at the agreed date. Though the seller can avoid a lot of banking charges and other costs, but he has no security that he will be receiving payment in due course. For this reason the exporter may not be willing to accept this sort of mode of payment. This system is also uncommon in Bangladesh.
3. Documentary Collection
This is an arrangement whereby the goods are shipped and the relevant bill of exchange (B/E)/(draft) is drawn by the seller on the buyer and documents are sent to the seller’s bank with clear instructions for collection through one of its correspondent banks located in the buyer’s domicile. In this method, you hand over the shipping documents to your bank and ask it to forward the documents to the buyer’s bank, with instructions to release them to the buyer on payment of your invoice. This is called cash against documents (CAD). You can also give your buyers trade credit by drawing a bill of exchange on them and requiring them to accept the bill when they collect their documents. This is called documentary collection against acceptance, or documents against acceptance (DAA) because the buyer accepts your bill of exchange.
Though the documentary collection is inexpensive and simple to arrange, the exporter is required to ship the goods without an unconditional guarantee or promise of payment by the buyer. However, as compared to cash in advance and open account, the documentary collection is a much more common means if payment by exporters.
4. Documentary Credits
The documentary credit or letter of credit is an undertaking issued by a bank to the buyer’s account (or for its own account), to pay the beneficiary (exporter) the value of the draft and/or documents provided that the terms and conditions of the credit are complied with.
This is the most frequently used method of payment for imports. Although one of the costliest, it is often considered the most secure because the buyer is assured that the seller will be paid only when the documents representing goods have been delivered. Conversely, the seller is assured that the buyer will receive the documents for the ultimate delivery of the goods only when payment has been made. The security of the transaction is assured by one or more third parties. This is normally the buyer’s bank (issuing bank),which issues the letter of credit (L/C) and the seller’s bank (advising/confirming bank), which informs the seller that the L/C has been issued and perhaps adds its confirmation to the L/C (in other words, guarantees the payment if the seller wants to be sure the issuing bank will not default).
In addition to the commitment of making payment by a bank to the exporters, the documentary credit provides legal security to the involved parties as it may operate within the framework of ICC’s (International Chamber of Commerce) Uniform Customs and Practice for Documentary Credits (UCP- 600). UCP-600 is an international codification of actual business practices, based on the experience of bankers, exporters and importers. It should be emphasized that the UCP rules apply when they have been incorporated by the parties in the documentary credit application forms. Because of the above-mentioned advantages, documentary credit is the most popular mode of payment in international trade.
In Bangladesh also, documentary credit is the most acceptable mode of payment in export and import trade.
The documentary credit operates as follows
The seller and the buyer first agree that a documentary letter of credit will be the method of payment. This agreement is usually spelt out in the sales contract. The buyer instructs his or her bank to issue the L/C, specifying the conditions that have to be fulfilled before payment is released. The issuing bank asks a local bank in the seller’s country to advise the seller and possibly also to confirm the L/C. In some cases, the advising bank may arrange for another institution to pay the seller. When the seller has fulfilled all the conditions set out in the L/C, he or she submits the appropriate shipping documents to his or her bank (or the bank agreed on) and collects payment. (See Box-3).
The documents (collectively known as the shipping documents) are proof that the goods have been shipped properly and as desired in the credit. These documents have been classified as follows:
- Transport Document (single or multimodal)v Insurance Document v Invoice v Others (including B/E, Certificate of Origin, Inspection Certificate, Packing List, etc.)
Documentary credit is basically of two types — revocable and irrevocable. However, the former is not permissible in Bangladesh, only irrevocable L/Cs are in use. All authorized dealer banks in Bangladesh are required to open (in case of imports) and entertain (in case of exports) only irrevocable L/Cs within the framework of UCPDC-500. Although the irrevocable L/C is the safest and most commonly used documentary credit, there are other forms of documentary credits such as Confirmed Irrevocable Credit, Revolving Credit, Red Clause Credit, Standby Credits, Transferable Credit and Back-to-Back Credit [for the brief definitions of these, see Box No-4].
SPECIAL TYPES OF DOCUMENTARY CREDITS
Confirmed Irrevocable Documentary Credit
A confirmation of an irrevocable documentary credit by a bank (the confirming bank) upon the authorization or request of the issuing bank constitutes a definite undertaking of the confirming bank, in addition to that of the issuing bank, provided that the stipulated documents are presented to the confirming bank or to any other nominated bank on or before the expiry date and the terms and conditions of the documentary credit are complied with, to pay, to accept draft (s) or to negotiate.
Revolving Documentary Credit
A documentary credit is one by which, under the terms and conditions thereof, the amount is renewed or reinstated without specific amendments to the documentary credit being required. The revolving documentary credit may be revocable or irrevocable, and may-revolve in relation to time or value.
Red Clause Documentary Credit
A red clause documentary credit is a documentary credit with a special condition incorporated into it that authorises the confirming bank or any other nominated bank to make advances to the beneficiary before presentation of the documents.
The standby credit is a documentary credit or similar arrangement, however named or described, which represents an obligation to the beneficiary on the part of the issuing bank to:
(l) repay money borrowed by the applicant, or advanced to or for the account of the applicant; (2) make payments on account of any indebtedness undertaken by the applicant; or
(3) make payments on account of any default by the applicant in the performance of any obligation.
Transferable Documentary Credit
A transferable documentary credit is a credit under which the beneficiary (first beneficiary) may request the bank authorized to pay, incur a deferred payment undertaking, accept or negotiate (the “transferring bank”), or in the event of freely negotiable credit, the bank specifically authorized in the credit as a transferring bank to make the documentary credit available in whole or in part to one or more other beneficiary/ies (second beneficiary/ies).
Back-to-Back Documentary Credit
The benefit of an irrevocable documentary credit (the primary credit) may be made available to a third party where the primary beneficiary uses the documentary credit as security/collateral to obtain another documentary credit (the secondary credit) in favour of the actual supplier. This secondary credit is known as back-to-back documentary credit.
Source: ICC Guide to Documentary Credit Operations, Publication No. -515
The terms of payment of (maturity date) irrevocable documentary credits are as follows:
- Sight Payment
- Deferred Payment
- Acceptance Payment
- Negotiation Basis Payment
It, therefore, appears that all the modes of payment have their own advantages and disadvantages. In general, the greater the security, the costlier the method.
A word of caution. While payment by documentary credit is generally considered safe, it does carry a risk in that, should the buyers decide for any reason not to honor their obligation to pay you or to delay payment, they can try to find some discrepancy between the documents you submit and the terms of the L/C. They may instruct their bank to withhold payment on the grounds that a document (such as a sanitary or phytosanitary certificate, for instance) does not conform precisely with what was required. You could, of course, bring a case against them and win, but you will have lost time and money in doing so. Furthermore, your bank could ask for its money back if it has given you an advance or discounted the L/C on the strength of the transaction.
No system is so secure as to dispense you from taking every care to know your buyers. You should find out how creditworthy they are and if their payment records are impeccable. Your bank may be able to assist you in this research.
B. Financing Techniques
Exporters, both traders, and manufacturers, need finance before and after shipment of goods to the foreign buyers. In each of these phases (before and after), exporters need different types of financial assistance depending on the modes of payments contained in export contracts or documentary credit. Moreover, these sorts of financial facilities are extended not only by banks but also by the traders (suppliers of raw materials and finished products) themselves, popularly known as trade credits. In the following sections, both trade and bank-related export credits have been presented.
a. Trade Credit: In most businesses, goods and services are invoiced by the seller (raw material supplier) and paid for by the buyer (ultimate exporters) at the end of the month or with a credit of 30, 60, 90 days or more. The period between the date of delivery and the actual receipt of the payment by the seller is the most prevalent form of credit.
Trade credit as it is called is a facility based on a pre-agreed arrangement between the buyer and the seller. It is the simplest, quickest to arrange and often the cheapest method for the buyer. Being based on mutual interest and trust between parties that have grown to know each other over a period, it does not normally involve pledging assets as security or drafting legal documentation.
Trade credit may, however, require the buyer to give the seller some form of
compensation for the facility granted, such as interest or exclusivity. Instead of paying by cheque or bank transfer, a buyer, with the agreement of the seller, may, on receipt of the goods, issue a promissory note. This is a form of IOU, in other words, a promise to pay in the future.
When the seller and the buyer are less well known to each other, or the seller is less sure of the buyer’s creditworthiness, the seller may prefer to issue a bill of exchange to the buyer. A B/E is defined as an unconditional order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand, or at a fixed or determinable future time, a certain sum of money to, or to the order of, a specified person, or to the bearer. In continental Europe, a bill of exchange is guaranteed by the buyer’s bank, as required by the seller. This type of B/E is known as aval.
The trade-credit form of export financing before the shipment of goods is widely prevalent in Bangladesh. However, unlike other countries, the extension of discounting facilities by banks to promissory notes or bill of exchange evidencing trade credits are not available in Bangladesh.
b. Bank Credit: Rather than obtaining trade credit, or in addition to it, you may decide that you need a more permanent outside source of finance to pay for goods and services. You could make this decision, particularly when, in your normal operating activities, the flows of cash inward and outward do not match each other perfectly, leaving gaps during which you are short of money. Provided your overall performance and cash flow are satisfactory, you can apply for short-term credit to financing institutions such as banks, specialized financial institutions, and others (see chapter 3).
A bank or a financial institution may provide credit both at pre-shipment and post-shipment stages. Pre-shipment credit takes the following forms:
1. Export Cash Credit (Hypothecation)2. Export Cash Credit (Pledge) 3. Export Cash Credit against Trust Receipt. 4. Packing Credit. 5. Back- to- Back Letter of Credit. 6. Credit against Red-clause letter of Credit.
1. Export Cash Credit (Hypothecation)
Under this arrangement, a credit is sanctioned against the hypothecation of the raw materials or finished goods intended for export. Such a facility is allowed only to major exporters. As the bank has got no security in this case, except for charge documents and lien of export L/C or contract, the bank normally insists on the exporter furnishing collateral security. The letter of hypothecation creates a charge against the merchandise in favor of the bank but neither the ownership nor the possession is passed to it.
2. Export Cash Credit (Pledge)
This credit facility is allowed against a pledge of exportable goods or raw materials. In this case, cash credit facilities are extended against the pledge of goods to be stored in the godown under the bank’s control by signing a letter of pledge and other pledge documents. The exporter surrenders the physical possession of the goods to the bank’s effective control as security for payment of bank dues. In the event of failure of the exporter to honor his commitment, the bank can sell the pledged merchandise for recovery of the advance.
3. Export Credit against Trust Receipt
In this case, the credit limit is sanctioned against Trust Receipt (TR). Here also, unlike the pledge, the exportable goods remain in the custody of the exporter. He is required to execute a stamped export trust receipt in favor of the bank, wherein a declaration is made that goods purchased with the financial assistance of bank are held by him in trust for the bank. This type of credit is granted when the exporter wants to utilize the credit for processing, packing and rendering the goods in exportable condition and when it seems that exportable goods cannot be taken into bank’s custody. This facility is allowed only to the major party and collateral security is generally obtained in this case.
4. Packing Credit, In this case, credit facilities are extended against security of Railway Receipt/Steamer Receipt/Barge Receipt/ Truck Receipt evidencing transportation of goods to the port for the shipment of the goods in addition to the usual charge documents and lien of export letter of credit. This type of credit is sanctioned for the transitional period from despatch of the goods until the negotiation of the export documents. The drawings under export cash credit(hypothecation/pledge) limit are generally adjusted by drawings in packing credit limit which is in turn liquidated by negotiation of export documents.
5. Back-to-Back Letter of Credit
Under this arrangement, the bank finances export by opening a letter of credit on behalf of the exporter who has received a letter of credit from the overseas buyer. As he (the exporter) is required to purchase raw materials for producing exportables, this new letter of credit is opened in favor of the supplier of raw materials within or outside the country.
Since the second letter of credit is opened on the strength of, and backed by, another letter of credit it is called back-to-back credit. The need for a back-to-back credit arises because the beneficiary of the original (export) letter of credit may have to procure the raw materials from the actual producer or supplier, who may not supply the raw materials unless its payment is guaranteed by the bank in the form of a letter of credit. The banks credit-related to back-to-back L/C is realized subsequently from export proceeds. “Assignment of proceeds” is another method of repaying a lender from export proceeds under a documentary credit arrangement. However, it is not practiced in Bangladesh.
6. Advance against a Red-clause Letter of Credit
Under a Red clause letter of credit, the opening bank authorizes the advising bank/negotiating bank to make an advance to the beneficiary prior to shipment to enable him to procure and store the exportable goods in anticipation of his affecting the shipment and submitting a bill under the L/C. As the clause containing such authority is printed/typed in red ink, the L/C is called Red Clause L/C. Though it is not prohibited, it is very rare in Bangladesh.
EXAMPLES OF FINANCING STRUCTURES FOR EXPORT TRANSACTIONS
Export of cashew nuts from East Africa to India
An exporter in East Africa receives an order for 3 tons of raw cashew nuts from a trading company in India he has not dealt with before. Payment will be in United States dollars by irrevocable letter of credit payable 60 days after loading CIP ICarriage and insurance paid to (… named place of destination)) onto a vessel. The exporter has about half the required amount of cash needed to buy the commodity from local farmers, transport it to a warehouse, obtain SGS certification on quality and quantity, bag it and load it into a container.
He obtains an advance in the local currency from his bank through an overdraft facility secured by amortgage on an unencumbered property he owns. He then signs the contract with the buyer in India who instructs his bank to issue the letter of credit.
With the money advanced to him by his bank, the exporter pays for the cashew nuts, road transport, certification, warehousing, containerization, insurance and freight.
Prior to shipment, his bank advises him that the documentary credit has been issued and that he will be crédited the full amount 60 days after loading on board the vessel. He is now safe in the knowledge that he will be paid, but first he must produce the documents that evidence shipment, origin, quality and quantity, the packing list, the insurance certificate and the invoice. His bank sends these documents to the buyer’s bank which then transfers the amount to the exporter’s bank when the credit term of 60 days matures.
The exporter then decides that he needs more cash to finance another transaction with another customer. His bank offers to discount the receivable that the documentary credit represents. The exporter calculates that it is to his advantage to accept the bank’s offer. From the proceeds of the discounting, he reimburses the bank the outstanding amount due and uses the balance of cash to complete his next transaction.
Export of garments from South-East Asia to Europe
A large and reputable European mail-order distributor of fashion wear places an import order for garments with a manufacturer in South-East Asia who accepts to deliver monthly over a six-month period. The two companies have dealt with each other for three years now, and it is agreed that trading will be on open account, with payment in deutsche mark on 90-day credit, but with a standby letter of credit as a safety measure.
After drawing up a production programme and a business plan showing that the transaction is profitable, the manufacturer consults her banker. She requires machinery, equipment and supplies, including cloth and accessories, some of which have to be imported from another country. As an exporter she is eligible for a number of advantages under an incentive scheme, including duty exemption on imported equipment, and can benefit from concessionary funds under a government-sponsored arrangement.
The bank, which has access to the concessionary funds through a special line of credit, arranges a buyer’s credit for the manufacture. The credit is secured by a guarantee from the export credit guarantee agency of the country providing the machinery and equipment, which are to be paid for in United States dollars. An agreement is drawn up which provides that the credit will be paid back to the manufacturer’s bank from the proceeds of the export order, as and when the monthly remittances are received from the buyer in Europe. To this effect, the manufacturer accepts to open a DM-denominated escrow account with her bank, out of which the debt will be serviced. The equipment will be paid for in full, at shipment.
The contracts between the manufacturer and the European buyer, and between the manufacturer and the equipment supplier are sioned. The manufacturer’s bank issues an irrevocable letter of credit in favour of the equipment upplier. The buyer orders his bank to issue standby letter of credit in favour of the manufacturer.
As an added precaution, to avoid losing out because of possible fluctuations between the dollar and the deutsche mark, the manufacturer hedges the risk by taking an option to buy dollars and sell deutsche mark.
Post Shipment Credit
Post shipment credit refers to the credit facilities extended to the exporters by the banks after shipment of the goods against export documents. The necessity for such credit arises as the exporter cannot afford to wait for a long time without paying manufacturers/suppliers. Before extending such credit, it is necessary for banks to look carefully into the financial soundness of exporters and buyers as well as other relevant documents connected with the export in accordance with the rules and regulations in force. Banks in our country extend post-shipment credit to the exporters through:
l) Negotiation of documents under L/C 2) Purchase of DP & DA bills 3) Advance against Export Bills surrendered for collection.
1. Negotiation of Documents under L/C
Under this arrangement, after the goods are shipped, the exporter submits the concerned documents to the negotiating bank for negotiation. The documents should be negotiated strictly in accordance with the terms and conditions and within the period mentioned in the letter of credit. If the documents are found to comply with the terms and conditions of L/C, the bank may purchase/discount the draft/documents.
2. Purchase of DP & DA Bills
In such a case, the bank’s purchase/discount the DP (Documents against Payment) and DA (Documents against Acceptance) bills operated under the payment method of documentary collection. While doing so, the banks should scrutinize all the export documents separately and minutely, and clear instructions have to be obtained from the drawer of the bill in regard to all important issues related to the negotiation of the bills.
Purchase and discount of bills under open account mode of payment have not been found to be practiced by the banks in Bangladesh.
3. Advance against Bills for Collection
Banks generally accept export bills for the collection of proceeds when they are not drawn under an L/C or when the documents, even though drawn against an L/C contain some discrepancies. Bills drawn under L/C, without any discrepancy in the documents, are generally negotiated by ‘the bank and the exporter gets the money from the bank immediately. However, if the bill is not eligible for negotiation, the exporter may obtain an advance from the bank against the security of export bills. In addition to the export bills, banks may ask for collateral security like a guarantee by a third party or an equitable/registered mortgage of property.
There are many other forms of export financing techniques namely, for faiting, buyer’s credit and escrow account system (for the interpretation of these techniques see box no. 6), is practiced in many developed and developing countries but these are not followed by the banks and financial institutions of Bangladesh. Even if these techniques are not found in practice, an exporter can discuss (with his/her bank) the possibility of structuring a financing facility based on these techniques as these are practiced in many countries. In fact, the range and quality of the facilities and services that banks and other financial institutions offer are often based on market demand and competition. To a great extent, It is up to customers to stimulate competition among banks and an improvement in the banks’ responses to their needs. Users of bank services must always be prepared to help their bankers to innovate and introduce facilities and mechanisms that correspond to the realities of their environment.
OTHER FORMS OF EXPORT FINANCING
Also known as forfait discounting, this is a method of discounting without recourse that is widely used in international trade. The exporter sells his/her receivable (which will be a bill of exchange issued by himself or herself, or a promissory note received from the buyer) to a forfaiter (normally a bank) who takes over the risk of non-payment. The discount deducted from the forfaiter’s payment to the exporter is calculated by the forfaiter, taking into account the period of credit, current interest rates, the creditworthiness of the buyer, the political risk of the buyer’s country etc.
This is a facility granted by a lender to a buyer, at the request of the buyer or the seller. It is normally granted for credit for large export orders, often of machinery and equipment and for terms ranging from less than a year to three or more years. It is more frequently used in large structured project-financing packages. The credit is normally granted by an institution in the seller’s country.
In international trade financing, an escrow account is an account opened by an exporter with a bank, usually overseas, into which one or (more usually) several buyers pay amounts owed to the exporter. The bank is given precise instructions by the exporter at the time the account is opened on how the money in the account is to be used. The account is then blocked in the sense that the escrow bank will only carry out transactions that conform with the terms of the escrow agreement.
An escrow account is normally opened by a borrower at the request of one or more lenders. It then serves as a general pool which is divided among several parties. It is rarely used for single transactions but can be very practical when large or regular payments are made by one or more buyers and the proceeds are used to reimburse one or more lenders and pay third parties abroad for services rendered. Escrow accounts overseas have to be authorized by the authorities of the exporters’ country.
The time period for which short-term credit is provided by our banks generally depends upon the expiry date of L/C or contract. The export policy 1997-2002 encourages banks to extend export credit up to 180 days. In case of some export items, as the period of 180 days is not adequate, the policy has increased the time limit to 270 days. However, a maximum of 120 days is the time limit for extension of export credit by our banks. In case of pre-shipment export credit, banks normally can extend it up to 90% of export L/C value (including packing credit) and in case of post-shipment credit, sometimes banks can even finance up to 100% of L/C value.
C. Other Facilities and Services
Related to export credits and payments, there are some other facilities and services available for the growth of exports of Bangladesh. These are as follows:
a. Export Credit Guarantee Scheme (ECGS)
Sadharan Bima Corporation introduced an Export Credit Guarantee Scheme with effect from January 1978 through its Export Credit Guarantee wing as per the order of the Government of the People’s Republic of Bangladesh in order to promote national exports.
The wing has been subsequently converted into an autonomous department having separate budgetary provisions and accounts.
The primary objective of the Export Credit Guarantee Department is to boost up and strengthen the export promotion drive in Bangladesh by:
l) Offering guarantees to banks and financial institutions to enable exporters to obtain easily better loan facilities both at the pre-shipment and post-shipment stage;
2) Providing a range of credit risk insurance covers to exporters against losses resulting from both commercial and non-commercial (political) risks in respect of goods sold to foreign buyers on credit.
Broadly speaking, the objectives of ECGS are to encourage exporters to export more, attract newcomers to export business, promote new export products and to open up new markets.
At present the following finance guarantee and policy are issued by ECGS:
l) Export Finance (Pre-shipment) Guarantee;2) Export Finance (Post-shipment) Guarantee;
3) Whole Turnover Export Finance (Pre-shipment) Guarantee;
4) Export Payment Risk Policy (Formerly known as Comprehensive Guarantee).
The Pre-shipment Credit Guarantee Scheme has been designed to protect commercial banks against losses on their pre-shipment credits due to insolvency of the exporter or due to his failure to repay the same within four months of the due date of payment, thereby encouraging the banks to grant pre-shipment advances to the exporters on a more liberal basis and easier terms than in the past so that our exports are not hampered due to a
shortage of working capital.
The Post-shipment Credit Guarantee has been designed to protect commercial banks from losses that may be sustained by them in respect of advances granted to exporters by way of discount, purchase or negotiation of export bills. It supplements the cover given to banks under the Pre-shipment Credit Guarantee.
The whole turnover export finance guarantee, designed to be issued in the name of a commercial bank, provides cover for all the pre-shipment credits that are extended by it to all of its customers under a single guarantee. In other words, it is a contract between the ECGS and the bank to whom the guarantee is issued and it protects the insured bank with respect for the losses that it may incur while giving pre-shipment credits to its exporter- clients. In comparison to individual pre-shipment finance guarantee, this guarantee is easy to handle, has less paperwork and less premium cost.
To remove the exporter’s risk of not being paid by the buyer for his credit sales and to overcome his post-shipment finance problem the export payment risk policy has been evolved. Moreover, the insured may assign the policy to the bank and such assignment facilitates the former in securing advances easily from the latter against shipment made under contracts.
Details of the Export Credit Guarantee may be seen in Appendix III.
b. Export Development Fund (EDF)
The main objective of creating an Export Development Fund at the Bangladesh Bank is to assure a continued availability of foreign exchange to meet the import requirements of non-traditional manufactured items. This facility is available to the non-traditional exporters, particularly newer exporters diversifying into higher value exports and exporters diversifying into new markets. An exporter identified as above is eligible to avail of EDF facilities on the basis of the conditions stated below: v He must be an exporter of non-traditional manufacturing items. v The domestic value addition of these products could be 20% except in the case of garments where it has to be 30% and above. v The loan should be utilized in order to import raw-material for the manufacture of the exportable products.v The exporter must have an export L/C. v He must create a back-to-back L/C for importing raw materials.v The period of the loan is 180 days.v The exporter can borrow as many times as he likes in a year.v The interest rate he pays is LIBOR+1% v An exporter can borrow an amount not exceeding $ 5,00,000 in a single case but the outstanding amount should not be over $10,00,000.v He has to have an Export Credit insurance through ECGS. v As for banker, the EDF allows a spread of 2.5% for the established exporters and 3.5% for the new exporters, for every loan to the client.
For details please consult Appendix IV.
c. Hedging Currency Risks
As an exporter, one of your concerns is to avoid losing money if the currency you are paid in by your buyer falls against your own or, conversely, if the currency you have to pay your overseas supplier rises against your own.
The problem becomes even more acute if you borrow in local currency from your bank or another financial institution.
Hedging offers several ways of overcoming the problem. The main principle is that you cover any risk of loss by ensuring that you receive or pay the equivalent amount you had originally expected.
One approach is to sell the dollars forward, in other words, at a later date but at a fixed price, so that when you are paid in dollars, you are sure of obtaining the amount you expected in your own currency.
Conversely, you may want to buy foreign currency forward to be sure you have the right amount to pay your supplier when your imported goods are delivered. Instead of buying and selling forward, you may also buy and sell currency options.
These give you the right, but not the obligation, to buy or sell currency at a given date for a given amount.
These and many more such mechanisms, are called derivatives and allow you to cover the risks of price and currency fluctuations.
In the context of Bangladesh, only forward booking facilities are available, and only for imports. Because of exchange rate arrangements and external sector policy of the government, exchange rates are usually adjusted downward. However, you should always raise the question of currency and price fluctuations with your banker when negotiating a short-term credit. He or she should be able to advise you and offer you the services that are available in Bangladesh.
HEDGING FOREIGN CURRENCY RISKS: AN EXAMPLE
Let us look at a simple case: you have won an export order which you will invoice in a foreign currency (dollars, for example), at say $ 100,000. You have given your buyer 90 days’ trade credit. To finance the transaction, you borrow from your local bank in the local currency (Taka) the equivalent of $80,000. Let us assume the rate of exchange is Tk.57.00 to $ l. The amount you borrow is then T k. 4.56 million. If taka stays the same or drops in value against the dollar, you will have no problem repaying your loan because you will get T k. 5.70 million or more for the $100,000 you are paid, But
what if the reverse should happen? If the dollar drops in value against the taka, you may not be able to repay your debt from the proceeds of your sale.
For instance, let us assume that when your payment comes through, the dollar is worth no longer Tk.57.00 but only Tk.55.00. The $100,000 payment is now worth only T k. 5.50 million. When you pay your debt, you will have no profit margin left. The transaction will have gained you nothing. What could you have done?
If she agrees, you could bill your client in your own local currency, i.e. Tk. 5.70 million. She then takes the exchange risk and when you receive full payment, it will be T k. 5.70 million. The problem is that your buyer may not be willing to do this, because she may not know in advance how many dollars she will have to remit to ensure you get the full T k. 5.70 million.
You match your borrowing currency with your payment currency. If you bill in dollars then you borrow in dollars. But this may not be possible in Bangladesh because of foreign exchange regulations or the lack of dollars at local financial institutions.
You discount your invoice with a discounter or forfaiter, without recourse, so that the latter, in effect takes the exchange risk (as well as the risk of non-payment). The problem may lie with the high rate of discount, which you have to weigh against the risk of devaluation of the dollar.
You know you will have to pay back T k. 4.56 million, so you sell forward an amount in dollars that will result in your getting T k. 4.56 million. Selling forward assumes there is a futures market in Bangladesh that deals in the currency you are invoicing in. In effect, a forward sale is a deal between you and an individual or an Institution under which you agree to pay a certain amount of dollars on an agreed date in return for getting Tk. 4.56 million on the same day. Depending on the assessment of the market for the dollar, you may have to pay a little more or a little less than the amount in dollars at the prevailing exchange rate on the day of the transaction. Normally, you pay a forward buying rate, usually determined by factors such as the prevailing interest rate and the historic rate of devaluation of the foreign currency. The deal can be reversed by buying forward the same amount of dollars and only paying (or receiving) the difference in taka on the day of settlement.
If there is great uncertainty, and you really do not know which way the dollar will turn, an alternative is to buy an option to sell the dollars on the day you receive payment. With an option, you are at liberty to go ahead with the transaction or not, depending on your assessment of the situation.
An option is comparable to an insurance policy and you pay a premium for the cover it gives you. In this example, the drawback is that a futures and options market do not exist in Bangladesh. Your best alternative, in that case, is to discuss with your bank whether there is any possibility to arrange a private deal between yourself and another trader whose risk is the reverse of yours.