Three years ago, the Bangladesh Bank allowed local banks to open "offshore banking units" with the good intention of letting them lend in foreign currencies to foreign companies operating in EPZs and high-tech parks in the country, which was the sole purview of foreign banks previously.
But the condition was that to be able to give out loans in foreign currencies, the local banks should form separate funds with deposits from non-resident Bangladeshis (NRBs) and foreign companies, and borrowing from financiers abroad.
Banks were allowed to provide financial facilities to fully foreign-owned companies in the export processing zones (EPZs), private EPZs, economic zones (EZs), and hi-tech parks at LIBOR plus 3.5% rate.
But, the conditions were relaxed afterwards, allowing foreign lending to local companies that do not have foreign currency earnings. And the offshore units were allowed to borrow foreign currencies from their own on-shore units or general banking units.
So, a big mismatch in foreign currency management started taking shape from this decision. The off-shore units started to give out loans to local companies in foreign currencies and take repayment in local currency.
This created a great balance sheet problem for the banks in general. On paper, they had foreign currency holdings but, in reality, there was a shortage of it, because that currency had already been given to the off-shore units for lending.
The off-shore units had a total foreign currency exposure of $9 billion at the end of October this year while they could build only $655 million in foreign currency deposits from NRBs and other foreign sources. Hence, almost the entire amount was borrowed from domestic banking units and from different banks, according to the Bangladesh Bank's data.
As such, dollars from on-shore units were mopped up by the off-shore units, creating the current dollar crisis for regular LC (letter of credit) opening.
The offshore banking policy says the funds that the off-shore unit of a bank will raise from internal sources will not exceed 30% of the bank's capital, but some banks including Dhaka Bank and Shahjalal Islami Bank were in such an aggressive off-shore lending spree that they have exceeded the limit.
Four other banks – AB Bank, Brac Bank, Premier Bank, and Social Islami Bank – are about to exceed the limit as their offshore borrowing from domestic banking units crossed 29% of regulatory capital in October this year, central bank data show.
In spite of not having any foreign currency deposits or borrowing from foreign sources, AB Bank lent $101 million from its off-shore unit till this October and the entire amount was borrowed from the domestic banking unit.
Similarly, Agrani Bank's offshore exposure stood at $198 million and the entire amount was borrowed from the domestic banking unit.
The rather reckless offshore lending by banks to local companies ultimately caused the foreign currency liquidity in their domestic banking units to dry up, making banks unable to make LC payments.
According to the Bangladesh Bank, of the total $9 billion offshore exposure of banks in October, $2.1 billion was borrowed from the domestic banking unit of respective banks and $5.4 billion from foreign or local banks.
As some banks could not pay back the money they borrowed from foreign banks for offshore banking operations, they now face being cut off from LC confirmation, said a senior executive of the Bangladesh Bank.
Representatives of some foreign banks recently held a meeting with the Bangladesh Bank in this regard, he added.
In this situation, the central bank is now planning to tighten the offshore banking operation by reducing the borrowing limit from domestic banking units to 20% of regulatory capital from the existing 30%, he said.
Where off-shore loans go
Most local banks lend to local importers from their offshore banking units against usance LC.
A usance or deferred letter of credit is a type of letter of credit used often in trade finance whereby the issuing bank must make payment to suppliers when relevant documents are presented.
However, the importer will get 180 days to make payments to the issuing banks, also local banks.
Once a sale contract is agreed upon between a buyer and a seller, the buyer can request that an LC be used to secure the transaction.
Using a deferred LC makes cash flow management even easier, because it gives you more time to pay for the goods, and therefore more time to utilise those goods for sale, which frees up working capital.
In such payments, issuing banks normally charge commission and administrative costs for LCs.
In offshore unit operation, most banks have lent to importers for usance LC after borrowing foreign currency from their regular banking units, said a senior executive of the Bangladesh Bank, adding that as a result, when import costs increased significantly in the wake of the Ukraine war, banks faced severe dollar shortage to run regular banking operation.
Even though, on paper, banks are in a surplus net opening position of the dollar, in reality, they do not have dollar liquidity. This is because the foreign exposure of offshore banking was shown as a net opening position as per offshore banking guidelines.
Banks are lending to local importers in foreign currencies, but they are getting repayment in the local currency.
This is how the mixing up of onshore and offshore banking operations has led to a crisis in the forex market, the central bank official concluded.