Home ›› 12 Aug 2021 ›› Opinion
Industrial inputs, capital machinery and few commercial goods are permissible for import under supplier’s/buyer’s credit. Foreign suppliers extend credit facilities against supply of goods to importers in Bangladesh under supplier’s credit. On the other hand, importers arrange credit from external sources to pay import payments to foreign suppliers at sight. At the end of maturity of credit, importers make payments to foreign lenders. Buyer’s credit is still young, it was introduced by central bank in 2012. But its journey was started through offshore banking units of few banks which were allowed to discount accepted import bills. The system is commonly known in the banking industry as usance payment at sight (UPAS) letters of credit (LCs).
Soon after financial crisis of the year 2008 of last decade, a new word came into existence – 90 or 120-day sight in Bangladesh export trade. It means that exporters will receive payment after 90 or 120 days from the date of shipments. But it is not possible to pay off import liabilities out of export proceeds at delayed receipt. To cope up with the necessity, export bill was found discounted from external sources on non-recourse basis.
Central bank issued general authorization to offshore banking units for discounting import bill in 2010. History shows that central bank allowed buyer’s credit in 2012 at all-in-cost of 6 per cent. In 2013, export bills were allowed to be discounted at the same rate. But early payments against export under open account were introduced in 2020.
The cost of financing for short term import finance and post shipment export finance in the name of bill discounting was fixed at 6 per cent. Later in 2019, the rate was linked with 6-month LIBOR (London Interbank Offered Rate) plus 3.5 per cent per annum.
History indicates that use of LIBOR rates was necessitated to the rise of US dollar denominated deposits held outside of USA in the 1960s. The origin of the term ‘LIBOR’ has been credited to a Greek banker called Minos Zombanakis, who was running the London branch of Manufacturers Hanover, now part of JPMorgan.
In 1969, he organized a syndicated loan at London interbank offered rate. As such LIBOR rates are in operation for a half century in the world since 1969.
In 2012, LIBOR was found to have been manipulated by individuals at various leading financial institutions. The event created shock waves in the financial system. LIBOR prices the market for unsecured wholesale term lending for banks. Since the global financial crisis, transaction-based submissions leading to LIBOR formation were tapered off with estimates as replacement. In 2017, British regulatory authority, announced that it would not use its legal power to mandate banks to poll LIBOR beyond end-2021. Starting from next year, one week and two-month LIBOR rate publication will be discontinued. However, publication of overnight, one-month, three-month, six-month and twelve-month shall continue till June 2023.
If we look at LIBOR introduction in Bangladesh, we can see that in 1989 EDF was introduced with benchmark rate of LIBOR. Afterwards and till today, external loans are priced at floating rate tagged with LIBOR rate.
As said earlier that LIBOR is continuing for half a century. The rate is forward looking, since there are seven types of tenor-link rates published regularly. But LIBOR rate is said to be risky. In place of LIBOR rate, alternative reference rates are in place worldwide. SOFR (Secured Overnight Funding Rate) will replace USD LIBOR. SONIA (Sterling Overnight Indexed Averaged Rate) will replace GBP LIBOR. TONAR (Tokyo Overnight Averaged Rate) is expected to replace TIBOR (Tokyo Interbank Offered Rate) in both JPY Libor and Euro-Yen. ESTER (European Short-Term Euro Rat) is going to replace EURIBOR (European Inter Bank Offer Rate) and EUR-LIBOR. SARON (Swiss Average Rate Overnight) is expected to replace Swiss currency LIBOR rate.
SOFR will be the most important and demanding rate as most international trade is settled in US dollar which is related to SOFR. In addition, ESTER, SONIA and TONAR are expected to play important roles in pricing loans and settling payment in the global financial market. The benchmark rate presently available in place of LIBOR rate is backward looking. All are overnight rates. No risk is said to be involved in the rate.
To cope up with the situation, central bank has already issued a notification stating that alternative benchmark rate of concerned currency of financing may be applied. Mark-up of 3.5 per cent annually may be added with the benchmark rate. But the benchmark rate being backward looking is allowed to be compounded. Officially it is said ‘compound in advance’ for export and ‘compound in arrear’ for import. In case of export bill discounting in USD benchmark rate, the rate needs to be compounded for the specified tenure ahead of the interest period. For example, one-month financing on 1 July of the particular year, the compounded rate would be calculated for the month of June.
In case of USD benchmark rate used in import financing, the rate needs to be compounded during the interest period. For example, for a one-month interest period beginning on 1 July of the particular year, daily benchmark rate needs to be compounded from 1 July to 31 July.
In view of the flexibility in period, 6-month will no longer be applicable rigidly. The tenure like 1-month, 3-month and so on will be flexible, depending on the credit period for financing as per the notification. It is said that the new benchmark rates published in different countries are risk free. Considering the issue, adjustment for risk premium not exceeding 2.50 per cent per annum on mark-up of 3.50 per cent is permitted to be added with reference/benchmark rate compounded in advance or in arrear as necessary, for the relative tenure. In this case, the risk premium will be around 0.09 per cent.
Islamic banking is a major part of Bangladesh banking system. In this context, the notification has allowed that globally recognized Shariah-based reference/benchmark rate should be applied instead of traditional one, with the prescribed mark-up.
What to happen on actual phasing out situation of LIBOR is unknown. It is expected that no adverse situation will arise. But the new benchmark rates are all backward looking. In simple words, it can be said that the new cost structure will be compounded benchmark plus risk premium of 0.09 per cent plus mark-up of 3.5 per cent annually. However, LIBOR can continue till its publication.
The policy note will support importers and exporters to bear financing cost at less than four per cent. In addition to short term trade finance, long term external finance is also linked with LIBOR rate. Since long term loans are obtained with specific permission from competent authorities like Bangladesh Investment Development Authority (BIDA) and Bangladesh Bank, LIBOR transition needs to be managed prudently so that borrowers will not face adverse situations. In this case, revised approvals should be specific with regards to risk premium adjustment factors. The rate structure may be - alternative benchmark rate with compounding in arrears plus a fixed per centage on mark-up in the same way as prescribed for short term financing program plus mark-up. It needs to be ensured that all-in-cost should not exceed a range of around five per cent. Approvals will not refer to the standard adjustment factors developed by various global agencies to keep borrowing safe from extra cost burden since the standard adjustment setters resonate lenders.
The writer specialises in international trade
