International Chamber of Commerce (ICC) found in its global survey covering 122 banks in 59 countries titled ‘Rethinking Trade Finance 2009’ that market momentum shifts towards open account terms and importers of North America, Europe and Asia clearly move from Letter of Credit (L/C) to open account settlement. Most source documents available today indicate that the percentage of open account transaction is usually around 80 per cent of world trade. Bangladesh is not an exception. Review of trade service operation of banks conducted in 2014 by Habib et al. in BIBM (Bangladesh Institute of Bank Management) shows that 84 per cent of import payments from the country were made through L/C in 2013. This figure was about 98 per cent in 2011. On the other hand, the same survey shows that L/C payment method was used in case of 49 per cent of the total export receipts in 2013. This was 60 per cent in 2011. It indicates that use of L/C in both export and import is being decreased very sharply and this downward trend is overly high in case of export from Bangladesh. Particularly, it is important to note that non-L/C trade is being increasingly used for our major export items namely RMG (ready-made garment), jute goods and leather. However, open account trade means that payment is received many weeks or even months after delivery. Unsurprisingly, exporters find that open account terms may create cash flow and default risk problems. On the other hand, banks also face certain challenges in financing open account transactions as under this system no bank offers guarantee of payment in case of failure of importer to pay. International factoring provides a simple solution to problems faced in case of open account trade regardless of whether the exporter is a small organisation or a major corporation. Mechanism of international factoring involves a five/six-stage operation, if it is carried out by members of FCI. It is noted that if any bank wants to offer international factoring, it needs to get membership either from Factoring Chain International (FCI) or the International Factoring Group (IFG). These groups regulate the international factoring activity of their member banks/factors. Mechanism followed here is as follows:
* The exporter signs a factoring contract assigning all agreed receivables to an export factor/bank. The factor then becomes responsible for all aspects of the factoring operation.
* The export factor/bank chooses an FCI correspondent to serve as an import factor/bank in the country where goods are to be shipped. The receivables are then assigned to the import factor.
* At the same time, the import factor investigates the credit standing of the buyer of the exporter’s goods and establishes lines of credit. This allows the buyer to place an order on open account terms without opening letters of credit. Consent of import factor/bank for establishing line of credit means certainty of paying 100 per cent of invoice to export factor/bank in case of importer’s inability to pay.
* Once the goods have been shipped, the export factor/bank advances up to 80 per cent of the invoice value to the exporter against documents.
* The import factor collects the full invoice value at maturity and is responsible for the swift transmission of funds to the export factor/bank who then pays the exporter the outstanding balance.
* If after 90 days past due date an approved invoice remains unpaid, the import factor will pay 100 per cent of the invoice value under guarantee.
The mechanism placed above indicates the simplicity of international factoring in conducting international trade compared to L/C. Additionally for opening L/C, importers have to provide required margin and sufficient security to their banks in order to confirm L/Cs. Even for a successful importer, there comes a time when the growing requirements for L/C margin goes beyond the importer’s financing ability and L/C coverage exceeds the security available to give to the bank. Moreover, importers need to approach banks for issuing L/Cs on each occasion of importing goods from abroad, which is really time-consuming. In L/C operation procedures, several banks, namely issuing bank, collecting bank, negotiating bank, presenting bank and confirming bank are involved. Involvement of many banks increases the cost of international trade and creates barriers in different steps of operation. Moreover, L/C confirmation fees take away a substantial amount of foreign currency abroad and increase the cost of international trade. Importers at home and abroad are therefore no more interested to import by opening L/C. International factoring is now a global industry with a vast turnover and is universally accepted as vital to the financial needs of all types of business. International factoring has become well-established in developing countries as well as in those that are highly industrialised. The total amount of international factoring conducted by FCI members in nearly 70 countries stood at 213.22 billion euros in 2012 whereas the amount of total factoring accounted for 2.1 trillion euros at the same time. A clear picture is available in the following table.
It is revealed that Asian region shows highest growth among all the continents although it stands only behind European region with respect to total volume. Export and economic growth always maintain a robust positive relationship irrespective of the size of economy. As a result, Bangladesh Government always makes it a top priority to improve the conditions that directly affect the ability of exporters to export. In this process, reaching new importers as well as unexplored market is important. In entering new competitive market, offering attractive credit terms are being used increasingly in addition to ensuring quality and fixing rational price of the products. As international factoring ensures offering attractive credit terms to the importers, Bangladesh may go forward to launch this product. However, many issues are likely to be encountered while launching this service. These issues are primarily related to the legal, strategic and organisational aspects. Moreover, a policy guideline is also necessary for procedures of client management, dispute handling and prevention, invoice processing and documentation, assignment of the export invoice, costing and pricing, approval and monitoring and activities of factor banks/financial institutions. These issues should be looked into thoroughly before launching this service. Dr. Prashanta Kumar Banerjee is Professor & Director (Research, Development & Consultancy), Bangladesh Institute of Bank Management (BIBM).
Source: https://www.thefinancialexpress-bd.com/2015/04/13/88614
