High LC confirmation fees make imports more expensive

by MMC
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Amid the dollar crisis in the domestic market for over a year, Bangladeshi importers are experiencing significantly higher costs due to increased letter of credit confirmation fees charged by foreign banks, mainly due to of the deterioration in the health of the banking sector.

And the burden of these rising costs is shifted directly to consumers, precipitating an unwelcome surge in inflation.

Importers now face confirmation fees of 3.5% of the value of their LC imports per year, a substantial increase from the 1.7% to 2% charged in June, bankers and businesses say from last year.

What further aggravates this situation is the change in the dynamics of LC imports. Previously, around a quarter of import letters of credit required third-party bank confirmations, but now more than 80% require such confirmations because banks are unable to open letters of credit on sight. Additionally, 100% deferred LCs, which have become common, must also be supported by confirmations from another bank.

To calculate the financial toll borne by Bangladesh through letters of credit in the first two months of the current fiscal year, The Business Standard turns to central bank data.

The figures reveal that in July and August, banks opened letters of credit valued at $5.55 billion and $5.59 billion respectively. Assuming that 80% of these letters of credit were confirmed at a rate of 3.5% by third-party banks, the resulting expense for Bangladesh amounts to $390 million, which translates to over 4,200 crore taka per year, which is ultimately borne by the consumers. . Even if the LCs were postponed for six months, the additional cost would be half of the estimated amount.

Mostafa Kamal, chairman of Meghna Group of Industries, one of the country’s largest importers of raw materials, expressed concern over the hike in letter of credit confirmation fees and attributed the increase in fees to the fact that most banks refrain from opening demand letters of credit.

He therefore finds himself forced to resort to UPAS LC, an import financing product operating according to a deferred LC system for importers. He said UPAS LCs require confirmation from a third-party bank to be accepted.

Additionally, the imposition of a 20% tax on interest payments related to foreign loans has further increased costs, pushing businesses to the brink, Kamal noted, adding: “If we fail to meet our payment obligations abroad, we risk default. What options do we have? to have?”

Syed Mahbubur Rahman, managing director of Mutual Trust Bank, also admitted that LC confirmation fees had increased significantly in recent months. This rise has led to higher import costs, which are ultimately passed on to consumers, thereby contributing to the overall inflation rate, he added.

In international trade, letters of credit issued by a buyer’s bank may be confirmed by a bank in the seller’s country or by a third-party bank, thereby ensuring that the seller will receive payment even if the originating bank defaults. the buyer. Banks that provide LC confirmation to Bangladeshi banks and importers include Standard Chartered, HSBC, Mashreq, JP Morgan and banks from Singapore and the Middle East.

How much more money is being spent?

Citing customs data, the central bank said Bangladesh imported $75 billion worth of goods in the past financial year.

Bankers said about 80%, or over $60 billion, of total imports were guaranteed by LC confirmation from a third-party bank. If the average LC confirmation fee was taken as 3% per annum, local importers paid an additional $1.8 billion or over Tk 19,000 crore that year.

Now the question is, if the rate hadn’t increased by 1.5 percentage points or 150 basis points, how much money the country could have saved. Assuming that 80% of total imports, or $60 billion, were guaranteed by LC confirmation from a third-party bank, the country could have saved $600 million, or over Tk6,600 crore, in the last exercise if LC confirmation fees had not increased. .

Why fees have skyrocketed

Usually, LC confirmation fees depend on four major issues: bank risk, country risk, importers and products.

This time, other risks have been added to the list. Of these, three are problems of local origin. These are the decline in the solvency of local banks, the downgrading of the country’s credit rating and payment delays or defaults.

The fourth reason is global: interest rates rising by 5 percentage points or 500 basis points in global financial markets. Bankers said this rise in global interest rates would lead to higher borrowing costs for banks. Banks, in turn, pass on some of these increased costs to their customers, including those seeking LC confirmation services.

Why LC confirmation fees are higher in Bangladesh

Bangladesh incurs significantly higher expenses than importers from other South Asian countries when it comes to confirming their letters of credit.

Even in Pakistan, a country facing high economic risk with dwindling foreign exchange reserves, falling exports and slow GDP growth, importers pay much less for letter of credit confirmation than their counterparts in Bangladesh .

In India, the confirmation fee is 0.75% for LCs worth up to Rs10 crore, and this fee is reduced to 0.50% for LCs exceeding Rs10 crore. On the other hand, in Pakistan, confirmation fees vary between 1.5% and 2.5%.

The managing director of a private bank, who preferred to remain anonymous, attributed the higher LC confirmation fees in Bangladesh to the shortcomings of local banks.

He pointed out that many banks opened letters of credit beyond their payment capacity, leading to defaults, which prompted foreign banks to increase rates.

There are exceptions, however, such as Dutch-Bangla Bank, which has managed to keep LC confirmation fees low. According to its Managing Director, Abul Kashem Mohammad Shirin, this success is attributed to their cautious approach of opening LCs based on their payment capacity.

He noted that despite a substantial decline in remittances through the bank, from over $200 million to $25-30 million per month, the bank has still met its obligations without default. “There is no magic behind it; we opened LCs based on our ability to pay,” he said.

The head of the treasury division of a large private bank said that many Indian and Pakistani banks have their branches abroad, especially in Middle Eastern countries, and these banks are working, including confirming letters of credit in favor of their respective countries.

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