Credit line cuts by foreign banks, rising LC confirmation charges add to inflation woes

A sharp reduction in trade credit lines from foreign lenders, coupled with a surge in Letter of Credit (LC) confirmation charges, is undermining efforts by Bangladesh's interim government and central bank to rein in stubbornly high inflation that has remained in double digits for over two years.

LC confirmation charges have jumped to 4%, up from 2.5%-3% earlier this year, adding significant financial strain on importers. This increase is forcing businesses to raise the prices of imported goods and services further fuelling inflation, according to bankers and importers.

"We're seeing costs skyrocket across the board due to a jump in LC confirmation charge and this is making it harder to keep prices stable," said Mostafa Kamal, chairman of Meghna Group of Industries, the country's top commodity importer.

Syed Mahbubur Rahman, managing director of Mutual Trust Bank, said an increase in LC confirmation charge directly hikes the cost of doing business.

 LC confirmation another snag

But importers argue that higher charges are only part of the problem. A bigger concern is that foreign banks are becoming increasingly reluctant to confirm their LCs, raising fears of disruptions to critical imports such as food, fuel, and raw materials.

"We are struggling to confirm our LCs, charges will come next," said a senior official of City Group, another large commodity importer. Consequently, commodity imports went down by around 30%, he noted.

According to the National Board of Revenue (NBR), between July and October this year, Bangladesh imported over 4.34 lakh tonnes of palm oil, a decrease from around 5.24 lakh tonnes during the same period in 2023.

Sugar imports dropped from 1.01 lakh tonnes to 0.81 lakh tonnes in the same period compared to the previous year.

Imports of other essential commodities, such as chickpeas and peas, also declined, while imports of soybean oil and lentils saw an increase.

What is credit line and how much Bangladeshi banks get

Trade credit plays a vital role in Bangladesh's banking and trade sectors, allowing local banks to finance imports without immediate foreign currency outflows. Under this system, a supplier's bank offers a credit limit to the borrower – often a Bangladeshi bank – enabling purchases on credit.

For example, a German bank might provide a Bangladeshi bank with a $100 million credit limit, serving as a guarantee to suppliers and confirming LCs, which offers added security for exporters.

However, the situation has become increasingly uncertain. Bangladesh's average monthly imports total $6 billion, and about $5 billion of LCs require third-party bank confirmation – usually by foreign banks. This creates a six-month credit line demand of roughly $30 billion. Yet many Bangladeshi banks fail to secure sufficient credit due to weaker financial standings.

Insiders say that Bangladeshi banks typically receive around $30 billion annually in foreign credit limits, which allows them to support import financing without depleting their own foreign currency reserves. However, recent drastic cuts in these credit limits – by at least 50% in some cases – have dealt a significant blow to the banking sector and importers alike.

Treasury officials say even the country's stronger banks have seen reductions of 30%-40% in their credit limits, while weaker banks face cuts of 50%-70%, and around two dozen banks no longer receive any foreign credit lines.

The head of one bank's treasury division described the situation as a major challenge for both banks and businesses, further straining an already fragile economy.

Which global banks provide trade finance for Bangladeshi banks

Banks from three key regions provide credit limits or trade finance to Bangladeshi banks. Western banks, such as Germany's Commerzbank, have long been involved in financing Bangladeshi trade.

Standard Chartered Bangladesh (SCB), with a decades-long presence in the country, and American Express, which operated in Bangladesh before merging with SCB, have also been significant players.

Also, global banking giants like Citibank NA and HSBC have supported Bangladeshi banks with trade credit.

Since the early 2000s, Middle Eastern banks have emerged as strong competitors. For example, the UAE's Mashreq Bank has become a major player, rivalling Western banks in both credit line offerings and competitive LC confirmation charges.

Later, banks from the Asia-Pacific region, particularly those based in Singapore and Japan, have entered the market further diversifying the sources of trade finance available to Bangladeshi banks.

As a result, LC confirmation charges remained reasonable at 1%-1.5% for years before it jumped to 2% or more in 2022, especially after the Russia-Ukraine war began.

Reasons of woes in LC confirmation charge and credit line 

Syed Mahbubur Rahman, managing director of Mutual Trust Bank, attributed the reduction in foreign credit limits for Bangladesh's banking sector to overdue payments, a downgrade in the country's credit rating since May last year, and a deterioration in law and order.

He added that Middle Eastern banks, which were once major purchasers of trade bills, have made the steepest cuts, forcing local banks to settle import bills using their own foreign currency reserves.

"The positive aspect is that Standard Chartered Bangladesh is providing significant support to local banks during this challenging period," Rahman said.

Naser Ezaz Bijoy, CEO of Standard Chartered Bangladesh, pointed out that LC confirmation fees are charged by overseas offices of the foreign correspondent banks based on demand (the availability of transactions) and supply (availability of risk appetite). There are four key factors influencing LC confirmation pricing – bank risk, country risk, funding cost, and profit margin.

"Foreign correspondent banks rely on market information to assess risk, and as it stands, the publicly available data are not encouraging," Bijoy noted.

He pointed to a reported 17% non-performing loan (NPL) ratio in the banking industry as of September, noting that foreign banks may interpret this differently based on their understanding of the sector's complexities beyond published data and their individual risk management approaches.

"Standard Chartered Bank being the largest and oldest international bank apply our deep market knowledge for determining our risk appetite and limit structure," Bijoy said.

He explained that the rise in NPLs is largely due to improved disclosure practices, which were already visible to banks like them but may not be to all locally non-presence banks. He added that even Moody's downgrade of Bangladesh's rating and outlook to negative from stable is not entirely based on new information.

Bijoy also noted that international banks evaluate returns against risk-weighted assets, often comparing Bangladesh to markets like Indonesia, Vietnam, or Malaysia. Overdue payments from Bangladeshi banks negatively affect foreign banks' risk appetite and confidence.

He expressed optimism about the improvement in banks' overdue trade obligations over the past three months and praised the central bank's firm stance on delayed payments. Notably, the central bank has issued a new circular imposing penalties on banks with overdue payment obligations.

"If a bank's or the country's credit rating worsens, LC confirmation charges may or may not rise as the pricing does not depend solely on the rating of one agency," he explained. However, Bijoy stressed that the bigger challenge is the adequacy of credit limits.

Despite these challenges, the SCB CEO said the situation is gradually improving. "Middle Eastern banks, which had nearly reduced their credit limits to zero in August, are starting to re-engage," he said, signalling a slow recovery in the sector.

What is the immediate remedy?

Biswajit Saha, director of Corporate and Regulatory Affairs at City Group, suggested that the ongoing challenges in trade financing could be alleviated by raising the single borrower exposure limit, currently set at 25% of a bank's capital.

According to Bangladesh Bank regulations, the funded exposure limit for a single borrower or group is capped at 15% of a bank's capital, with an additional 10% allocated for non-funded exposure.

"If the funded exposure limit is increased from the current 15%, the situation can improve," Saha explained.

He pointed out that banks provide limits in local currency, but the nearly 40% depreciation of the taka against the dollar over the past two years has significantly reduced the effective credit limits for businesses.

For instance, Saha noted that a company with a Tk100 crore credit limit in March 2022 could secure $11.63 million at the then exchange rate of Tk86 per dollar. However, with the taka now trading at around Tk120 per dollar, the same Tk100 crore limit equates to just $8.33 million, drastically shrinking the company's borrowing capacity.

"This reduced limit prevents banks from confirming LCs," Saha said, adding that they have taken the issue to the central bank and the ministry of commerce urging them to increase the single borrower exposure limit.

Prior to 1 April 2022, banks could lend up to 35% of their total capital to a single borrower, split into 15% funded and 20% non-funded loans. However, following the sharp depreciation of the taka, businesses began urging an increase in the single borrower exposure limit in early 2023. Despite these demands, the central bank rejected the proposal in May of last year.