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Modernising the system of bank guarantee in foreign exchange

FE Team | Published: July 24, 2017 18:34:57 | Updated: October 24, 2017 15:06:31

Modernising the system of bank guarantee in foreign exchange

The Bangladesh Bank (BB) brought about some changes in the Foreign Exchange Regulation a few months ago, allowing commercial banks to issue bank guarantee in foreign currency without its prior approval. This is, of course, a very praiseworthy initiative which should have been taken much earlier. When we used to work in a commercial bank about 20 years back, we had to wait weeks after weeks to obtain permission from the concerned department of the Bangladesh Bank in order to issue guarantee in foreign currency. Following the recent change in Foreign Exchange Regulation, this bottleneck is now over and commercial banks will henceforth be able to handle bank guarantee transaction independently, irrespective of currency of the instrument. 
During the last two decades, our economy has tremendously grown as reflected in the size of the national budget, GDP (Gross Domestic Product), volume of international trade, amount of foreign investment and our overseas investment. Our foreign exchange reserve increased from US$ 1.0 billion to US$ 30 billion during this period. So many sections and clauses of our Foreign Exchange Regulation have become either obsolete or inconsistent with the recent practices and the structure of transactions. 
Once upon a time, obtaining a supplier's report was inevitably required for opening the letter of credit (LC) for US$ 5,000 and above and this threshold figure was determined when dollar value was about Taka 30. Now the dollar value is over Taka 75 and many compliance requirements have been developed for verification of the trading partner. Even the sources of published data are now available in the internet. So obtaining formal credit report on supplier is no longer required in most cases. Nevertheless, this requirement is still there in our Foreign Exchange Regulation and only minimum threshold has been increased to US$ 10,000. Similarly, travel quota for selling foreign currency remains what was 20 years ago. There are many sections in the Foreign Exchange Regulation which are not found to be consistent with the present economic condition and thus need to be updated in order to make it timely and appropriate. 
RECENT CHANGES: It is learnt from newspaper reports that changes have been made allowing authorised dealers (ADs) of commercial banks to issue guarantee in foreign currency to facilitate foreign firms' business activities in Bangladesh. It is further said that these guarantees can be issued on behalf of non-residents in favour of residents in the country. While elaborating the changes, it has been mentioned that ADs may issue guarantee, bid bond or performance bond. It has been found that it is technically a partial change. According to this change, prior approval from the BB is not required only when ADs want to issue guarantee in foreign currency on behalf of a foreign company or a person who is identified as non-resident and in favour of a local company or body. 
In all other situations, the requirement of obtaining prior approval from the BB is still required for ADs to issue guarantee in foreign currency. For example, if any local company is required to issue bank guarantee in US dollar in favour of any foreign company for legitimate business purposes, ADs will not be able to issue this kind of guarantee without prior approval from the BB. Even the circular has specifically stipulated only two types of guarantee, viz., bid bond and performance bond but there is another type of guarantee which is advance payment guarantee (APG). The recent changes have not mentioned anything about APG implying that APG cannot be issued in foreign currency without prior approval from the BB.  The circular did not talk about confirmation of Standby Letter of Credit (SBLC) issued by foreign bank in foreign currency in favour of a local entity which will put the ADs in a difficult situation in handling this type of transaction.   
Bid Bond, Performance Guarantee (PG) and Advance Payment Guarantee (APG) are three common instruments used in trade finance transaction. Even these three instruments are equally important and integrated in many situations especially when the value and size of underlying transaction are enormously high. Bid Bond is used in tendering process and performance bond is used when the tender is awarded while APG is used for advancing mobilisation fund. When any tender is invited, bid bond is inevitably required because this guarantees two type of uncertainty associated with the bidding process. In spite of winning the bid, the successful participant may not accept the assignment or the participant may withdraw its participation in the middle of bidding process and both situations will jeopardise the whole process. 
After awarding the contract, some other uncertainties arise such as the contractor may abandon the work without completion or the work can be inordinately delayed or cannot progress as per pre-determined schedule or quality of work can be compromised. The principal always wants to ensure that the risk associated with these uncertainties is well-mitigated and therefore, obtains performance guarantee which is drawn whenever either of the situations arises. When the value and size of underlying transaction is enormously high, initial outlay of fund is also significant, the applicant party or contractor can hardly mobilise from his or her own source. Conceding this situation, the principal always extends advance money as mobilisation fund which also involves some sort of uncertainty likely to arise out of the contractor's sudden departure after taking advance mobilisation fund. 
Therefore, the principal always tries to ensure certainty of advancing fund by way of taking advance payment guarantee which is drawn whenever the fund is not fully adjusted or paid off from the bill. There is interrelation among these three types of guarantees as bid will be drawn if PG cannot be provided and similarly, the work cannot be completed if APG cannot be provided and then PG will be drawn. So banker always conducts in-depth analysis with a view to ascertaining the applicant's or customer's ability to purchase all three kinds of guarantees i.e. bid, PG and APG. At the same time, bank also appraises its position of issuing all three guarantees on behalf of its customer. Otherwise, issuing only bid bond or PG may result in encashment of the guarantees. So, the current change will not serve the purpose of guarantee operation if issuance of APG in foreign currency without prior approval from the BB is not permitted. 
Building infrastructure, undertaking mega projects and development works are continuously carried out throughout the year in almost all countries. The scope, size and volume of this work in the developing world are extensively high because there is an ample opportunity of development in those countries. Moreover, this development work is always a very long-term project. Bank guarantee plays an important role in undertaking as well as accomplishing the project. Every stage from bidding process to the work completion, final delivery and quality assurance require submission of different kinds of bank guarantee. Apart from this, import-export business has also taken a new dimension as the use of LC is disappearing and a new concept of trade through open account or under bilateral contract accompanied by  Standby Letter of Credit (SBLC) is getting popularity. So time is not far away when SBLC or guarantee and counter-guarantee will become common financial instruments supporting all sorts of international trade. Under this situation, allowing banks to issue guarantee in foreign currency is a very effective initiative but this should be made very comprehensive covering all aspects.            
The writer is a banker based in Toronto, Canada.
nironjankumar_roy@yahoo.com

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