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Bangladesh’s Largely Unnoticed Problem: Financing

A credit shortage, sparked by several scandals in the RMG sector, is hurting many small and mid-sized manufacturers, and even causing some to close. Back-to-back letters of credit (LCs) have become almost impossible to obtain, creating serious problems for firms financing the manufacture of orders.

The Bangladeshi RMG sector relies on letters of credit for financing – a system based on proving export orders to safeguard duty-free status. Bangladesh imports almost all of its raw materials, and if those materials are being used for an export order, then they can be imported duty-free. To prove an order is for export, foreign buyers deposit an LC in a local bank, then the manufacturer gives a second, smaller LC to the raw materials supplier.

On top of that, the manufacturer is able to draw 10 percent of the LC before the order is completed, as a packing credit (PC). That money is used to pay wages for workers while the goods are being made. Once the goods are shipped, the bank releases the rest of the money from the LC.

The credit freeze started when Hallmark, a firm supposedly producing export orders, opened a letter of credit for roughly $1 million using a fraudulent purchase order. With falsified documents, Hallmark gave the letter of credit to a supposed yarn seller. However, no yarn was purchased and no goods were made – Hallmark and the fabric seller, which was owned by the same person, pocketed the money. The total corruption was over $325 million by Hallmark alone. Later investigations by the central bank found much more corruption from other factories in Bangladesh.

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Because they were not producing anything or exporting anything, there was no money to pay back the bank. Now banks have become more cautious and no longer issue back-to-back LCs. As a result, firms have to either self-finance manufacturing based on purchase orders (which small and medium-sized firms can rarely afford to do), or only deal with clients who can deposit an LC immediately.

Zulficar Ali Turaz, head of Bangladesh sourcing for Synergies, said, “A lot of small entrepreneurs are actually affected by the banking crisis. Many of them are closing down.”

This is leading to consolidation in the industry, as big factories with more capital are buying up smaller factories as they close.

Even for large firms, banks have put a cap on the packing credit to limit their liability. Banks are also performing extensive background checks on LCs.

“Now, they want to know what the reputation of the customer is, and they discourage factories from taking 90-day LCs, because it means the bank has to front the money. We are having difficulty with many medium factories who say that they can’t work on 90-day LCs because the bank will not support them,” said Turaz.

Many of these factories are closing down, said Turaz. Larger firms with more available capital are buying others. This consolidation in the industry has broad ramifications for buyers, because subcontractors, which are mostly small factories, are doing much of the low-cost production in Bangladesh.

To ease the crisis, the government needs to make more credit available to firms and instruct the central bank to ease restrictions. These actions have not been forthcoming, says Turaz, and there are serious questions about possible connections between the Hallmark scandal and the bank board of directors appointed by the government. The BGMEA has not taken any visible action on the issue either, seeing it as primarily a market concern.