Bangladesh is having a bitter experience during the Covid-19 period regarding the non-payment of export proceeds from foreign buyers. While some buyers did not pay at all, some asked for a concession. This puts the country's export earnings at stake. To overcome this problem and to hedge the non-payment risk of foreign buyers, factoring is a possible option to safeguard our export industry.
Bangladesh Bank has also issued a circular to facilitate factoring under open account export. It also provides access to international funds. Moreover, it allows electronic presentation of documents which reduces exporters' time and cost and makes them more competent in the business.
Factoring is a receivable based financing technique under open account trade where the exporter sells his receivables to a financial intermediary (Factor) and takes advances to meet the working capital requirement under an agreement. It's a product of international trade finance. There are four parties in factoring; exporter (Client), the importer (Customer), export factor (Financial Intermediary) and import factor. Through this financing, our exporters can enjoy continuous cash flow by selling their receivables to factors. Factoring improves their working capital requirements to sustain the business. Export factoring is based on the creditworthiness of a company's customers, rather than the borrowers' financials. Hence, exporters need not pay any collateral to secure such financing. Besides, advance financing reduces the risk of the non-payment tendency of importers.
Under the process, the exporter gets a purchase order from the importer. As per the order, the exporter ships goods to the importer followed by an invoice for payment. As the factor is assigned to make the payment, h/she makes a prepayment to the exporter. A factor can make as much as 80% of the payment in advance. Export factor assigns those account receivables to the import factor, later on, the export factor collects the payment from the importer and gives it to the exporter.
Factoring also acts as working capital finance instead of traditional collateral-based financing to the exporters. Hence it reduces the average receivable collection period substantially. This also minimises the operational cycle time of the exporters. Here, the financial intermediary who buys an exporter's receivables also provides credit protection to the receivables. This credit insured approach safeguards exporters in case of importers' defaults on payment.
Factor Chain International (FCI) of Netherlands, is the global standard settler body that regulates Factoring throughout the world by giving three sets of rules and procedures:
(1) The General Rules for International Factoring (GRIF), (2) The edifactoring.com rules, (3) The Rules of Arbitration, under UNIDROIT convention of UN
To become factors, banks or other institutions have to take membership from FCI, then the members can make communication among themselves globally, create transactions following the edifactoring.com rules and make arbitration in case any dispute arises under the two-factor system.
As per the Guidelines for Foreign Exchange Transactions (GFET), Volume 1, Chapter 8, section 13(a), proceeds of exports must be received by exporters within 120 days from the date of shipment. But a factoring loan can be given up to 180 days. If one of our exporters receives 80% of his receivables from a factor in advance and the rest of the proceeds (20%) will be repatriated after 180 days followed by collection from the buyer. This will make EXP overdue being full export proceeds were not realised within 120 days as per GFET. Hence the exporter is not able to take other services from the bank like LC opening and EDF financing. This makes operational complexity.
Guarantee commission against payment undertaking and interest with relevant charges are six months LIBOR plus 3.50% per which may not be satisfactory to the exporters, as EDF costing is still six months LIBOR plus 1.50% per annum, which is too low.
Against giving payment guarantee to the exporter, factors take insurance coverage through import factors, to minimise the non-payment risk of importers at cost of the exporters. This increases exporters' cost further.
The base for calculating the interest of the factors was set to LIBOR. But it will be eliminated from the first of January 2022, which may create unwanted complexities.
Lack of available foreign or international factors is another barrier. Correspondent banks have not included this type of financing in their product basket yet.
If local (Bangladeshi) banks want to do factoring business as export factors, firstly they have to be members of Factor Chain International (FCI), Netherland, which costs EURO 11,500 for a year. The renewal fee for the first 3 years is EURO 5000 and the next 3-year cost is EURO 7500 approximately. The membership fee paid to the factor abroad along with 20% withholds tax is a cost burden for the local banks in deciding the viability of offering such products to their exporters.
Factoring requires electronic presentation of documents but most of the Bangladeshi banks have not developed the technical arrangement for such presentation. Even the trade professional bankers are not well trained by the banks in this regard.
Most of our export contracts have a condition of buyer nominated supplier for BTB (Back to Back Letter of Credit) LC. In such a situation, the performance of export under the open account and performance import under LC is complex as well as costly for our exporters. Because LC is costly in terms of huge bank commission and when factoring cost is added, the total cost will reduce the profit margin as well the competitiveness of our exporters.
There are operational risks that represent the risk of human operational error and can be mitigated through the minimisation of manual work with the implementation of high-end software for managing the factoring transactions.
The probable risk of disputes between the assignor and debtor is a challenge. The others are performance risk of the exporter and credit and payment risk of the import factor, defective or false or fake invoices but there is no local law or guideline on how the dispute will be resolved.
Government has yet to ratify the UNIDROIT Convention of International Factoring(Ottawa, 28 May 1988)
Considering all the challenges, we should go forward step by step. As the pressure from the foreign buyers for open account trade keeps rising, there is no way without accepting it immediately. On the contrary, our exporters seem to be slowly responding to it. Increased awareness is necessary to improve the situation. Both bankers and exporters need to be educated with the mechanism of factoring. Adoption of required technologies is also important.
The government needs to ratify the UNIDROIT convention immediately. Ensuring adequate access for foreign factors in our country is necessary in this regard. Country credit rating is one of the barriers to doing so.
By ensuring good governance and proper AML, CFT compliance as per FATF 40 recommendations, we can increase our sovereign credit rating which will help us attract more foreign factors and reduce the factoring cost as well.
Respective to EDF financing, the cost of factoring determined by Bangladesh Bank, seems very high. If there is a scope, the rate may be evaluated further to lessen the burden on our exporter. As LIBOR will be discontinued from 2021, Bangladesh Bank should consider another alternative for cost calculation basis before December 2020, so that we can easily cope up with the LIBOR transition. The central bank needs to clear the confusion whether or not EXP will be overdue after 120 days. To maximise the benefit of factoring, Bangladesh Bank should extend export proceeds realisation time from 120 days to 180 days under factoring only.
Factors will have to take insurance coverage to hedge the non-payment risks. This also opens new doors for the insurance business. Government should find a way-out, how local insurance companies can grab this opportunity. Bangladesh International Arbitration Centre (BIAC) should come up to resolve the dispute arising from factoring transactions in collaboration with Bangladesh Bank and the factors. A dispute settlement guideline should be issued in collaboration with all parties.
Even though the viability is complex, factoring has a high potential and we are on the right track to lead the issue. More discussions along with operational procedures can give us a complete solution to this prospective financing for our exporters to tackle the non-payment risk of foreign importers.
Salim Ahmed CDC is a banker and analyst. He can be reached at email@example.com
Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions and views of The Business Standard.