Financial Express: LCs and garment exports
Originally published here (The Financial Express).
Letter of credit, as a system to protect the interests of the exporter and the exporting country, is no longer in conformity with the purpose for which it is executed. There are better alternatives and some countries have already moved to a more flexible model. So should Bangladesh.
The system of managing the export of goods, known as “documentary letter of credits”, dates back to the Egyptian times.
Over the centuries, this system turned into letters of credit. With the advent of the telex, letters of credit became electronic. With the coming of the SWIFT system, letters of credit have become electronic messages, securely exchanged between banks. This is the system we know today.
But these technology changes have created other issues.
Letters of credit used to be very short. This was because, when transmitted by telegram or telex, there was a charge for every letter of every word. In recent times, letters of credit have become fully computerised. Instead of one or two conditions, it is now quite common to find 10 or 15 conditions applied. This is because a buyer can specify any number of measures that have to be met, sitting at his computer, transmitting his instructions electronically to his bank – and the bank faithfully reproduces these conditions on the letters of credit that they transmit by SWIFT.
A letter of credit that proposes conditions that cannot be met provides no guarantee of payment to the exporter. Bangladesh experience with payment for garment export is dismal. For small mistakes in typing in documents, delay in shipment, small difference of packing, etc., are many reasons cited by buyer to make the consignments “stock-lot” at port of destination and incur demurrage. The exporters have no choice other than to agree to price and other compensation to accept the documents and payments.
There is no public data on what proportion of letters of credit are settled against conformity with documents, and what proportion are settled against discrepant documents (the latter being the situation when the letter of credit guarantee has fallen away). It is commonly felt that over 95 per cent of import letters of credit that Bangladeshi exporters are relying upon are discrepant.
Each letter of credit adds, maybe, US$2,500 of costs for a garment export transaction. Whether this cost is paid by the buyer or the exporter, it is a cost that the transaction has to bear. The costs arise through the issuance and risk fees that an international bank charges, followed by the additional fees for processing discrepant documents and then dealing with each bill of lading (if they are consigned to the international bank). If there is no actual guarantee of payment (because the documents are or will be discrepant), then this is a high fee for what is received. But there are two benefits that are received. The benefits are the safeguarding of (a) valuable shipping documents and (b) the proceeds of export. The letter of credit system ensures that the buyer does not receive the documents unless he pays for them, and ensures that the proceeds of the shipment come back through the banking channel (and therefore is correctly accounted for tax and earnings).
These safeguards are important. The Bangladesh Bank guidelines rightly state that shipping documents must not be sent directly to the buyer unless there is a payment in advance. Bitter experience shows that buyers can sometimes use the shipping documents to take the cargo without paying. Moreover, our system of foreign exchange controls has protected the country properly – and so must not be undermined.
Other countries are not labouring with letters of credit in the same way as we do. China, India, Vietnam, Cambodia – all of these countries have more relaxed systems (or no system at all) in these respects. Local banks and local factories are trusted to be sensible.
Analysis of the central bank regulations suggests that there is no problem here. In fact, we could be as flexible as our counterparts in other RMG-exporting countries. What we face is a local banking system that is hiding behind decades of custom and practice, they are supporting a letter of credit system that only enriches international banks at the expense of our exporters, and which does not suit the purpose any longer. There is nothing in the regulations that states that a bank letter of credit is mandatory if cash is not paid in advance, nor that it is mandatory that shipping documents are processed through the banking channel.
The only requirement is that documents must not be sent to the buyer without a payment in advance (which many buyers are not happy to do).
There are alternatives to the letter of credit system which are significantly quicker and cheaper for exporters. Local banks, in the interests of their clients, should be taking a flexible view on these matters and should trust themselves to make good decisions within the central bank regulations.
More importantly, the methods of delivery of export documents directly to the buyer (with endorsement of local bank) ensure income of local banks. On the face of it, Bangladesh is not likely to achieve financial and logistic capacity to handle export of garments worth US$50 billion by 2050 unless the matter is addressed urgently. If Bangladesh can achieve its medium-term of goal of US$50 billion worth of RMG exports by the 50th founding anniversary of the country, it will be able to reduce cost of products and burden of working capital and augment its income from exports.
The writer is a Legal Economist.