Amid a dollar crunch for over a year in the domestic market, Bangladeshi importers are experiencing significantly higher costs because of escalating LC (letter of credit) confirmation fees charged by foreign banks, primarily driven by deteriorating health of the banking sector.
And the burden of these rising costs is being transferred directly to consumers, precipitating an unwelcome surge in inflation.
According to bankers and businesses, importers are now burdened with confirmation fees of 3.5% of their import value on LCs per year, a substantial increase from 1.7%-2% charged in June last year.
What compounds this predicament further is the shift in import LC dynamics. Previously, approximately one-fourth of import LCs had required third-party bank confirmations, but now more than 80% need such confirmations as banks are unable to open sight LCs. Moreover, 100% deferred LCs, which have become common now, must also be supported by confirmations from another bank.
To calculate the financial toll incurred by Bangladesh through LCs during the initial two months of the current fiscal year, The Business Standard turns to data from the central bank.
The figures reveal that in July and August, banks opened LCs valued at $5.55 billion and $5.59 billion, respectively. Assuming that 80% of these LCs were confirmed at a rate of 3.5% by third-party banks, the resulting expense for Bangladesh stood at a substantial $390 million, which translates to more than Tk4,200 crore annually, which is ultimately borne by consumers. Even if the LCs were deferred for six months, the additional cost burden would be half of the estimated amount.
Mostafa Kamal, chairman of Meghna Group of Industries, one of the largest commodity importers in the country, has expressed concern over the surging LC confirmation fees and attributed the increase in the fees to most banks refraining from opening sight LCs.
Consequently, he finds himself compelled to resort to UPAS LC, an import finance product operating under a deferred LC system for importers. He said that UPAS LCs require confirmation by a third-party bank to be accepted.
Also, the imposition of a 20% tax on interest payments related to foreign loans has further elevated costs, pushing businesses to the brink, noted Kamal, adding, "If we fail to meet foreign payment obligations, we risk defaulting. What options do we have?"
Syed Mahbubur Rahman, managing director of Mutual Trust Bank, also acknowledged that LC confirmation fees have increased significantly in recent months. This surge has resulted in higher import costs, which are ultimately passed on to consumers contributing to the overall inflation rate, he added.
In international trade, LCs issued by a buyer's bank can be confirmed by a bank in the seller's country or a third-party bank, ensuring that the seller receives payment even if the buyer's bank defaults. Banks that provide LC confirmation for Bangladeshi banks and importers include Standard Chartered, HSBC, Mashreq, JP Morgan, and banks in Singapore and the Middle East.
How much additional money is being drained out?
Quoting customs data, the central bank said Bangladesh imported $75 billion worth of goods last fiscal year.
Bankers said that around 80% or over $60 billion of the total imports was backed by LC confirmation by a third-party bank. If the average LC confirmation fee was considered 3% annually, then local importers paid an additional $1.8 billion or over Tk19,000 crore in that year.
Now the question is if the rate did not increase by 1.5 percentage points or 150 basis points, how much money the country could have saved. Assuming that 80% of total imports or $60 billion was backed by LC confirmation by a third-party bank, the country could have saved a staggering $600 million or over Tk6,600 crore in the last fiscal year if the LC confirmation fees had not increased.
Why the charge has skyrocketed
Usually, LC confirmation charge depends on four major issues – bank risk, country risk, importers and products.
This time some other risks have been added to the list. Of these, three are home-grown problems. These are declining local banks' creditworthiness, downgrade in the country's credit rating and delay in payments or default.
The fourth reason is global – the interest rate hike by 5 percentage points or 500 basis points in the global financial markets. Bankers said this increase in global interest rates would lead to higher borrowing costs for banks. Banks, in turn, pass on some of these increased costs to their customers, including those seeking LC confirmation services.
Why LC confirmation charge is higher in Bangladesh
Bangladesh incurs significantly higher expenses compared to importers in other South Asian nations when it comes to confirming their LCs.
Even in Pakistan, a country facing high economic risk with dwindling foreign exchange reserves, declining exports, and slow GDP growth, importers pay considerably less for LC confirmation compared to their counterparts in Bangladesh.
In India, the confirmation charge is 0.75% for LCs valued up to Rs10 crore, and this charge reduces to 0.50% for LCs exceeding Rs10 crore. In contrast, in Pakistan, the confirmation charge ranges from 1.5% to 2.5%.
The managing director of a private bank, who preferred not to be named, attributed the higher LC confirmation charges in Bangladesh to the shortcomings of local banks.
He pointed out that many banks opened LCs beyond their payment capacity, resulting in defaults, which prompted foreign banks to escalate the rates.
Yet, there are exceptions, such as Dutch-Bangla Bank, which has managed to keep LC confirmation charges low. According to its managing director, Abul Kashem Mohammad Shirin, this success is attributed to their prudent approach of opening LCs in alignment with their payment capacity.
He noted that despite a substantial drop in remittance inflow through the bank, from over $200 million to $25-$30 million per month, the bank has consistently met its obligations without default. "There is no magic behind it; we've opened LCs based on our payment capacity," he said.
The head of the treasury division of a leading private bank said many Indian and Pakistani banks have their branches overseas, especially in the Middle Eastern countries and these banks do work, including confirming LCs in favour of their respective countries.