Why offshore borrowing not taking off

Infograp: TBS

The country's foreign exchange market has started to feel the pinch as recent changes to the interest rate cap on trade financing, along with the reimposition of tax on interest paid on offshore loans, have discouraged foreign borrowing, creating devaluation pressure that is already evident in the recent volatility of the dollar.

Bankers say the two policy changes have made foreign lenders more cautious, narrowed financing options for importers, and increased import costs.

The banking sector has been facing exchange rate volatility since early July, with the interbank dollar rate climbing to nearly Tk124 after remaining below Tk123 for about a year.

The central bank has also suspended dollar purchases from banks for the past one and a half months amid mounting depreciation pressure. In FY26, the central bank bought $6.4 billion when the taka was under appreciation pressure. Its last purchase was on 4 June.

Although the impact of the policy changes is not yet fully visible because of weak import demand amid a sluggish business environment, bankers warned of potential volatility in the dollar market if offshore funding becomes less attractive while export earnings and remittance remain insufficient to finance trade.

Shift from UPAS LCs to Sight LCs

Explaining the recent dollar volatility, the treasury head of a private commercial bank, who requested anonymity, said changes to the tax treatment of foreign borrowing have prompted many importers to shift from UPAS (Usance Payable at Sight) letters of credit (LCs) to Sight LCs to avoid the additional tax burden.

In the latest national budget, the government also reintroduced a 20% income tax on interest payments for offshore loans, ending the exemption granted in 2024. The tax was reimposed at a time when the country needs to attract greater inflows of overseas funds.

An offshore loan is a financing arrangement in which a borrower secures funds from a lender located in a foreign country, typically through an offshore banking unit.

Immediate payment requirements under Sight LCs would increase demand for US dollars, placing additional pressure on the foreign exchange market, the banker said.

He said a UPAS LC allows an importer to obtain short-term financing from a foreign bank, usually for 60 to 180 days. The foreign bank pays the exporter immediately, while the importer repays later. As this constitutes foreign borrowing, the interest is now subject to the reimposed tax.

By contrast, a Sight LC requires immediate payment once compliant documents are presented. As there is no extended financing period, it avoids the additional tax burden associated with UPAS financing.

The banker further said the tax has made UPAS financing less attractive, prompting importers to opt for Sight LCs despite the greater liquidity requirement.

However, the shift comes with higher immediate demand for US dollars because importers must arrange payment upfront instead of after 60-180 days. As a result, they need foreign currency immediately, increasing spot demand for dollars.

He said large importers can hedge part of their exposure through forward contracts, although the scope for such hedging is limited. Consequently, greater reliance on Sight LCs could add short-term pressure and volatility to the dollar market.

He added that while banks generally ensure dollar availability before opening a Sight LC, the shift away from UPAS financing could tighten foreign exchange liquidity and increase funding pressure on import-dependent businesses, particularly on commodities such as sugar and edible oil.

If cross-border borrowing declines because of the additional tax burden, the banker warned, the domestic foreign exchange market could come under further pressure. Unless export earnings and remittance inflows increase sufficiently, banks may have to rely more heavily on local dollar liquidity or arrange more expensive sources of foreign currency funding.

Interest rate ceiling

Another consequence is the central bank's 3% interest rate ceiling on short-term offshore borrowing, which has discouraged foreign lenders from extending credit to Bangladesh.

In April, the central bank instructed banks through a circular that interest rates on trade finance must not exceed SOFR plus 3%, tightening the previous ceiling of SOFR plus 4%.

Before the circular, banks could charge around 7.51% on UPAS LCs. Following the new cap, the rate has fallen to around 6.51%. By comparison, banks can charge 12% to 13% on local currency loans.

Soon after the circular was issued, the Association of Bankers Bangladesh (ABB) requested the Bangladesh Bank to revise the cap, warning that it could increase devaluation pressure because banks would be unable to meet short-term trade financing needs adequately.

The ABB also warned that interest rates on local currency loans could rise as demand for domestic borrowing increases. It said shortages of funds for short-term trade financing would increase the cost of doing business and keep inflation elevated, contrary to the central bank's policy objectives and the country's current economic needs.

Speaking to TBS, Syed Mahbubur Rahman, managing director of Mutual Trust Bank, said the 3% interest rate cap is making the business much less attractive for banks.

"We requested the central bank to reconsider it because everyone – including the IMF – is saying that the borrowing cost is already more than 2.5%," he said.

Cap on short-term trade finance concern for international lenders

The treasury head of another private commercial bank, who also requested anonymity, said long-term borrowing has remained largely unaffected, but the 3% cap on short-term trade finance has become a concern for international lenders.

Foreign banks have already begun renegotiating pricing with Bangladeshi banks, although the impact on borrowing volumes is not yet evident because demand for trade finance remains weak, he said.

The banker said the bigger concern is that correspondent banks view regulatory pricing caps as a departure from standard market practice. International lenders invest heavily in assessing country risk, allocating capital and building correspondent banking relationships. If lending rates are administratively capped, they may lose the incentive to provide financing or expand their exposure to Bangladesh, he added.

He further said if offshore funding becomes less attractive, importers may increasingly rely on direct buyer's credit or bill discounting from overseas financial institutions. However, the new Finance Act taxes interest on such cross-border financing, raising borrowing costs that are ultimately likely to be passed on to consumers.

He also warned that domestic banks could lose leverage in negotiating terms. Banks currently use their broader relationships with customers – including loans, deposits, payroll services and other business – when arranging trade finance. If financing shifts offshore, those relationships become fragmented, weakening local banks' bargaining power.

He added that importers forced to replace cheaper foreign currency borrowing with costlier local currency loans would face financing costs typically three to four percentage points higher, driving up the prices of imported goods.

Bangladesh Bank data show commercial banks' foreign deposits posted a net inflow of $391 million during July-May of FY26, compared with a net outflow of $1.14 billion in the same period a year earlier.

Although stronger foreign borrowing recently turned the balance positive, bankers expect inflows to weaken in the coming months because of the recent policy changes.