Bankers warn 3% ceiling may render trade finance unviable, seek rate revision

The Association of Bankers, Bangladesh (ABB) has urged Bangladesh Bank to reconsider its recently imposed cap on foreign currency trade financing rate, warning that the ceiling could make short-term trade finance commercially unviable for banks.

The bankers' body in a letter on 14 May formally requested a revision of the maximum interest on foreign currency trade financing set at SOFR plus 3%. TBS has obtained a copy of the ABB letter.

The association warned that the revised ceiling could strain banks' ability to meet demand for short-term trade financing, potentially disrupting trade and business activity.

Foreign currency trade financing is a type of banking credit used in international trade where businesses borrow or manage funds in a foreign currency to support import transactions.

Importers in Bangladesh typically rely on short-term trade financing through UPAS (Usance Payable at Sight) Letters of Credit (LC) to bring in goods.

Earlier this month, the central bank in a circular instructed banks that the interest rate on trade finance must not exceed SOFR plus 3%, tightening the earlier ceiling of SOFR plus 4%.

Before the circular, banks could charge around 7.51% in UPAS LC. After the new circular, it stands around 6.51%. On the other hand, banks can charge 12-13% in local currency.

Several industrial groups said lower rates would ultimately reduce borrowing costs for importers. However, bankers cautioned that any disruption to the overall trade financing system could have negative consequences for the broader economy.

Meanwhile, economists warned that a contraction in trade finance could push importers to buy dollars directly from the market, increasing liquidity pressure in the banking system, driving up interest rates, and adding upward pressure on foreign exchange demand.

'Difficult to operate trade financing under new ceiling'

Managing directors of several private commercial banks told TBS that it would be extremely difficult to operate trade financing businesses profitably under the revised ceiling.

They said banks with offshore banking units source foreign currency funding for import financing from overseas lenders at about SOFR plus 2.50%-2.75%. After adding statutory liquidity requirement costs, the effective funding cost rises to nearly SOFR plus 2.80%.

With the cap set at 3%, bankers warned that profit margins would shrink significantly. They said maintaining at least a Tk1 margin per dollar is essential to keep the business viable.

Bankers also cautioned that the cost of raising foreign funds could increase further, as international credit rating agencies have recently adopted a negative outlook on Bangladesh.

Fitch Ratings this month said Bangladesh's long-term debt repayment capacity may weaken and revised its outlook on the country's Long-Term Issuer Default Rating to "negative" from "stable", while keeping the B+ rating unchanged. The B+ rating still indicates that Bangladesh is considered capable of meeting its debt obligations.

Bank MDs said such negative outlooks often make foreign banks reluctant to extend foreign currency financing. Even when they do, lenders impose higher confirmation charges on LCs.

A senior bank official said a large share of importers are financed in US dollars. "The situation is now such that foreign banks providing dollar funding may start demanding 3%, particularly in the wake of Fitch's negative outlook."

In that case, banks in Bangladesh may become reluctant to extend dollar-denominated loans to these clients and would instead have to shift lending to local currency.

Meanwhile, importers said they prefer UPAS LCs because dollar-denominated financing is cheaper than borrowing in local currency.

They warned that if banks cannot source dollars through offshore banking units due to shrinking profit margins, they will face financing difficulties, while increased taka lending could expand money supply and fuel inflation further.

Bangladesh Bank spokesperson said comments would be provided after reviewing the letter.

A senior central bank official said the initial proposal had suggested reducing the interest rate further to 2%, before it was later set at 3%.

What ABB letter says

The ABB in its letter said that at present, well-rated banks can access trade financing at around 2.75%. After incorporating statutory costs, the effective all-in cost rises to roughly 3%, leaving banks with a margin of only about 1%.

"Therefore, if the revised circular comes into effect, banks may find such business commercially unviable," it said.

The letter added that, given Bangladesh's current sovereign rating, the all-in cost of long-term trade financing often exceeds 3%. It noted that these funds are not always perfectly matched to long-term exposures and are frequently used for short-term financing, pushing effective short-term funding costs above 3%.

Possible impacts

The ABB in its letter warned of several possible impacts.

It said the new rate could add pressure on the exchange rate. If banks scale back dollar lending, importers may shift to taka loans to purchase dollars for settlement, increasing short-term foreign exchange demand and pushing the exchange rate higher.

Greater reliance on taka borrowing could lift local currency interest rates, shifting the overall interest rate structure upward. Combined with tighter liquidity and exchange rate pressures, this would raise the cost of doing business, the ABB said.

The letter cautioned that global lenders could become more risk-averse under the new cap. Amid ongoing global uncertainty, trade financing costs are expected to rise further.

The ceiling may reduce foreign lenders' appetite for the Bangladesh market, as they may expect pressure from local banks to compress margins to remain within the 3% limit. This could further tighten trade financing liquidity in the banking system.

In view of these concerns, the ABB urged Bangladesh Bank to reconsider the circular.

Cap could shrink trade finance availability: Economist

Zahid Hussain, former lead economist at the World Bank's Dhaka office, said external sources of trade finance could gradually dry up.

He said Bangladesh Bank's decision to cap trade finance rates effectively benefits certain players but makes it difficult for many banks to operate within the margin, as no institution can sustain losses in this segment.

"As a result, inflows of foreign funding could slow or stop," the economist said. "If trade finance access tightens, importers would be forced to buy dollars from the local market, increasing demand for taka liquidity, even though such demand would otherwise have been met through trade finance channels."