Wednesday, 6 July, 2022

Increasing LC Margin Not Enough to Stabilise Dollar Market

Increasing LC Margin Not Enough to Stabilise Dollar Market
Nironjan Roy

During the last few months, foreign exchange market, particularly the dollar market, has been very volatile which resulted in devaluation of local currency. This volatility in the foreign exchange market is not only the problem of our country but also for many other countries. Again, fluctuation in the foreign currency market is a very common phenomenon. However, the international market is going through acute uncertainty due to the Russia-Ukraine war. Besides, financial, and political debacles in Sri Lanka has also created a tacit fear. Therefore, volatility in the dollar market in our country is being viewed with caution and serious attention by the policymakers, think-tank, economist and particularly guardian of the country's money market, Bangladesh Bank. Under this situation, the concerned government authorities as well as Bangladesh bank has taken some measures with a view to stabilising the dollar market before the situation goes beyond control. The measures so far undertaken among other include (I) increasing LC margin for non-essential items, (II) relaxing conditions / documents requirement for remitting foreign currency, (III) providing incentive on foreign remittance, (IV) restricting foreign trips, (V) discouraging foreign currency expenditure, and (VI) exercise careful consideration while undertaking new project. These are of course praiseworthy measures; however, we will have to wait for the outcome of these action plans.

Impact of changing LC margin: At the time of establishing LC (Letter of Credit), importers are required to deposit a certain percentage of LC amount to the bank, what is commonly known as LC margin. Amount of LC margin entirely depends on the banker-customer relationship within given parameters set by the country's central bank, Bangladesh Bank. Banks may open LC with zero or nil margin for their customers with very good standing, while banks may demand very high margin for the customers with poor standing. Maneuvering LC margin i.e. either increase or decrease of the LC margin is a very common phenomenon in our country’s banking industry because Bangladesh Bank uses this tool to control import volume. LC margin is increased when the central bank decides to reduce import volume or vice versa. This mechanism, which is although questionable about its desired outcome, may work when an overall liquidity crisis prevails in the country’s money market. Because of tight liquidity situations, importers face difficulty in managing higher amounts of margin which may eventually discourage opening of LCs for importation of non-essential items. Again, the liquidity market consists of both local currency and foreign currency including US dollar and margin is usually retained in local currency. So, increasing LC margin may help improve the country's overall liquidity market but may not equally work for foreign currency market. 

 Adverse impact in dollar market: Bangladesh Bank’s decision to increase LC margin may ostensibly seem to be contributing to stabilising the dollar market in the country but actually may not happen, instead may cause adverse impact. Because margin is deposited in local currency i.e. Taka what is used to buy dollars for making payment against LC when LC document is received. Importers can easily mobilize local currency for LC margin since there is no apparent overall liquidity crisis and thus can establish LC for importation of goods. When LC documents are received by LC opening banks, demand for dollars arises in order to effect payment against LC. As per UCPDC (Uniform Customs and Practice of Documentary Credit), there is a certain deadline to make payment under LC provided a compliant document is received. So, the LC opening bank becomes desperate to buy dollars at any cost in order to make payment which eventually creates tremendous pressure on demand for dollars resulting in destabilization in the dollar market. For example, an importer desires to establish LC for USD 10 million and as per new requirement, if 90% margin i.e. taka 830 million which is equivalent to 9 million US dollar is required to be deposited. In normal money market conditions, the importer can easily manage this fund. However, when the bank will receive compliant documents against this LC, that bank will remain under compulsion to purchase 9 million US dollar using taka 830 million margin from the foreign currency market. This type of demand for dollars creates additional pressure in the dollar market which eventually deteriorates the dollar crisis.

Appropriate measures: If Bangladesh Bank really wants to utilize margin tools to reduce the pressure on the demand side of dollar, then they should revise the margin policy. In order to discourage importation of luxury and non-essential items and thus reduce the pressure on demand for US dollar, initial margin against establishing LC must be increased with the condition that the margin amount will have to be deposited in LC currency i.e. if LC is opened in US dollar requiring payment obligation in dollar, initial margin must be deposited in US dollar too. This measure will help the importer and LC opening bank arrange the required amount of dollars prior to making commitment of future payment in dollars through establishment of LC. If the importer can comfortably and conveniently arrange / buy dollars required for depositing initial margin, the LC will be established otherwise not. Under this arrangement, LC opening banks will never remain under a compelling situation of making dollar payment within the stipulated time for which bank and / or importer becomes desperate to arrange dollars at any cost which eventually creates an upward push in the dollar market. So, Bangladesh Bank should revisit their policy and revise stating that LC margin whatever is the applicable rate must be provided in the LC currency or US dollar in order to effectively discourage importation of luxury and non-essential items and thus reduce the pressure on the demand for dollars in the foreign currency market.

Foreign remittance: Bangladesh Bank has also relaxed some conditions and documents requirements for inward foreign remittance in an attempt to increase the supply of dollars, which is of course a praiseworthy move. However, there is no initiative of widening the scope of directly remitting US dollars through the banking channel. During the last few years, most banks in our country have miserably lost their correspondent relationship with large foreign banks particularly banks in the USA, Canada and Europe. Consequently, the scope of remitting money through banking channels have been limited. Most banks in the USA, Canada and Europe have terminated correspondent relationships and even closed RMA (Relationship Management Agreement) with most of our banks due to non-compliance and deteriorating condition of our banks’ performance. Even our banks have not taken this measure with serious attention, rather simply ignored it which has now left them in a difficult situation to undertake international trade. Remitting money directly through the banking channel has considerably declined as remittance fee has exorbitantly risen because remitting money through banking channel now requires involvement of more than one or two intermediary banks. A few months ago, one of my relatives had to pay more than two hundred dollars to remit only six thousand dollars to Bangladesh through a banking channel. Because he had to deposit money to JP Morganchase bank which did not have any correspondent relationship with banks in Bangladesh. So, they had to go through another intermediary bank, Standard Chartered Banks and both banks charge a remittance fee of more than two hundred dollars. Whereas, if banks in Bangladesh could maintain correspondent relationships with JP Morganchase or any other bank in America, remittance cost could be only eighty dollars. Bangladesh Bank may be surprised with this statement, however, they can easily find the rightness of these words, if they collect all banks’ active list of their correspondent banks.

Bangladesh is now emphasising on money transfer agents for foreign remittance which should not be the correct approach. Most money transfer agents keep both options open i.e. direct remittance through banking channel and sending money through non-banking channel which is commonly known as hundi. For direct remittance, the agents have to rely on bank and nowadays, all money transfer agents have to face very stringent compliance requirements because of the anti-money laundering act, so they categorically encourage expatriate Bangladeshis to send money through non-banking channels. We may blame or criticize them, but this is a kind of new reality. If we really want to keep direct remittance through banking channels in an increasing trend, our banks will have to restore their correspondent relationship with foreign banks and gradually increase the number of correspondent banks in the USA, Canada and Europe. Even so, our banks will have to establish RMA with the maximum number of banks abroad. We hope Bangladesh Bank will review this correspondent relationship situation of our banks seriously and will accordingly direct them. 


The writer is a Banker, Toronto, Canada.

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