An open account transaction is a sale where the goods are shipped and delivered before payment is due
On June 30, Bangladesh Bank issued a policy circular titled "Export under open account credit terms against payment undertaking payment risk coverage with the option of early payment arrangement on a non-recourse basis." It is a long-awaited policy circular that has garnered a mixed reaction among the concerned stakeholders. The circular is basically on post-shipment export finance under open account terms alias factoring.
Open account is not a new concept in the international trade arena. It has been a popular method of trade transaction in the developed countries, particularly in the European countries, not to speak of the USA, for quite a long time. Many of the Asian countries, including the emerging economies, are also practicing it nowadays. Even in Bangladesh, there has been limited practice of domestic factoring, a trade finance technique to mitigate the likely risk under the open account.
An open account transaction is a sale where the goods are shipped and delivered before payment is due. This option is considered very much advantageous for the importer in terms of cash flow and cost, but it is likely to be a high-risk option for an exporter. The export market, nowadays, is getting highly competitive globally, and due to this intense competition, foreign buyers often exert pressure on exporters for open account terms.
The exporters, in turn, also resort to competitive open account terms, taking into consideration the point of mitigating the risk of non-payment by using appropriate trade finance techniques, such as factoring, export credit insurance, bank payment obligation etc.
The circular under reference basically deals with factoring, which was permissible in the Export Policy of 2015-18. It is a post-shipment export finance facility for receivables under open account credit terms against payment undertaking payment risk coverage. So it does not categorically cover import factoring, although more or less comprehensive guidelines on international factoring have been attached to the circular.
International factoring, in fact, facilitates the availability of adequate cash flow by the factoring companies, commonly known as factors, in cross border trade, by providing advance payments to exporters for goods supplied by them and thereby safeguarding their interest from importers' probable inability to pay.
International factoring is, therefore, a method of trade financing which serves as a form of export insurance for the exporters. By allowing open account for export receivables through factoring, it has opened up the window for alignment to international practices. Maybe it is a humble beginning of a greater trajectory of full-fledged international factoring in due course of time.
This is the first time electronic presentation of relevant documents has been allowed by Bangladesh Bank to realise export proceeds from the import factor. Even in case of default by importers, payment is to be ensured by the designated institutions in accordance with appropriate underlying arrangements for settlement on the basis of physical or electronic presentation of export invoices/ bills/ documents.
In order for mitigating risk, payment guarantee is to be given by designated institutions like international factoring companies/ foreign banks/ foreign financial institutions/ trade financiers/ insurance entities. However, it is not clear why insurance entities have been included in the list of designated institutions. Is it permitted under the Insurance Act?
Early payment by designated institutions abroad on a non-recourse basis will create cash flow problem for the exporters. It will be more so for the SMEs, which very often suffer from cash flow problem. Banks abroad or factors may not always agree to provide early payment on a non-recourse basis.
Authorized Dealer (AD) banks may allow transport documents to be issued in the name of importers or other nominated parties as per arrangements of factoring. This provision would lessen the hassle of entanglement of a number of financial institutes, as is the case of documentary letter of credit (LC).
In the LC-based method, banks have enough control over transactions but in case of open account transactions, control of banks over transactions is minimum, entailing risk for getting payment, but the risk can be minimised through factoring. Membership of Factors Chain International (FCI) has been allowed for the banks and the fee for membership can be remitted without permission of Bangladesh Bank, which will help ease of doing business.
With the issuance of the circular under reference, as we are heading towards international factoring, it is required that the same be ratified in UNIDOIT, the Convention on International Factoring. Similarly, since the underlying contract is the Sales Contract in such factoring, uniform format for sales contract through ratification of UNCITRAL may be adopted to ensure legal enforceability of the contract.
In fact, the cost is a big concern for the acceptance of the product. As per the existing circular, expenses to exporters for guarantee commission against payment undertaking and interest for early payment against export bills or receivables shall not exceed 6-month USD LIBOR plus 3.50 percent annually. The reality is that if the cost appears to be high to the exporters, it will not be acceptable to them.
The reason is that the said BB circular has been issued with reference to Para 25, Chapter 8 of GFET-2018 wherein there is an opportunity for discounting of usance bills in foreign exchange through OBUs, financial institutions abroad or international financing institutions. Moreover, AD banks can borrow (para 24, ibid) US Dollar funds from the EDF of Bangladesh Bank at a very nominal rate.
With the tremendous development of ICT, global economies are getting more integrated day by day, resulting in easier access to exporters and importers themselves for getting dependable information. So they are less willing to pay for risk protection afforded by traditional methods. This has led to a preference for open accounts where invoices play a very vital role; banks can provide value through Supply Chain Finance (SCF), taking care of invoices and funding suppliers (and buyers) against invoices.
Nevertheless, international factoring is gaining popularity day by day throughout the world encouraging us to be aligned with the international community. At present, 90 countries are practising factoring; there are 400 members of FCI and annual turnover is €2.40 trillion. Since open account alias international factoring is a maiden issue to be dealt with, there is arduous need for large scale awareness and capacity building, knowledge and skill-sharing among the stakeholders.
For the purpose, the Central Bank, Bangladesh Institute of Bank Management, International Chamber of Commerce, Training Institutes of the respective banks, and Research Institutes of the Trade bodies should come forward to extend their effective cooperation.
Md Ahsan Ullah is the former executive director of Bangladesh Bank and a member of ICC Bangladesh Banking Commission.