Collateralized Finance Against External Guarantees

 

Collateralized finance -lending against secured assets - forms the backbone of risk management for financial institutions. By accepting eligible collateral, lenders reduce exposure to default risk, while borrowers gain access to credit on more favorable terms. Among the different forms of collateral, deposits held with banks are some of the most common and easily manageable sources.

However, the application of this concept becomes complex in cross-border contexts, particularly for foreign-owned companies. Traditionally, these companies face hurdles in arranging acceptable collateral for local financing. Recognizing this, central bank has taken a landmark step by allowing offshore deposits to be used as collateral for onshore loans - a policy that could reshape the foreign direct investment (FDI) landscape.

Collateralized lending refers to a financing mechanism where banks provide loans against a borrower's assets. These assets may range from fixed property and equipment to financial instruments like term deposits, securities, and guarantees. When borrowers pledge deposits as collateral, it is often seen as low-risk financing since the asset is highly liquid.

In practice, deposit-backed lending is a common banking product. Depositors who need liquidity before maturity of their term deposits can borrow against those deposits. Banks typically charge an interest rate slightly higher than what is earned on the deposit, allowing depositors to meet urgent cash requirements while maintaining their long-term savings instruments.

Though deposit-taking is straightforward, accessing loans often involves additional complexities. Banks demand a banking relationship - commonly referred to as the 'banker-customer relationship’ as well as collateral that meets regulatory and internal risk thresholds. In many cases, cash flow-based collateral, personal guarantees, and even corporate guarantees fall short in meeting banks’ security requirements, especially for working capital needs.

Bangladesh has opened its economy to foreign investors across nearly all sectors. Foreign investment inflows play a vital role in financing infrastructure and long-term development. However, capital investment alone is rarely sufficient to complete projects. Additional debt financing is often required, usually in the form of local currency working capital loans.

Foreign-owned companies, despite holding equity, often struggle to access domestic banking finance. While they may establish the required banking relationship, the absence of local assets to offer as collateral becomes a critical obstacle. Term loans may become available after several years of operations based on performance and regulatory assessment, but working capital loans are harder to secure at the early stages of business.

 Unlike local firms, which can leverage owners' personal assets or extended corporate guarantees, foreign firms typically lack the flexibility to pledge such local collateral. Additionally, many foreign shareholders are based abroad and cannot easily offer their personal or corporate assets within Bangladesh’s jurisdiction.

In such cases, third-party guarantees come into play. These may include assets of individual shareholders, personal guarantees, or external corporate guarantees. While local entrepreneurs can use such instruments to support their borrowing, foreign investors face significant barriers due to regulatory complexities in cross-border collateralization.

In many countries, a practical workaround exists: foreign companies maintain deposits in the destination country and use those deposits as collateral to obtain loans for their local operations. These deposits, often held in foreign currency, provide assurance to banks and enable access to liquidity without requiring physical assets within the borrowing country.

For a long time, this practice was not streamlined in Bangladesh. Though banks have been operating Offshore Banking Units (OBUs), which allow foreign currency deposits and offer attractive terms -such as tax exemptions on interest earnings - these deposits could not be readily used as collateral for loans in local currency without specific approval from central bank.

This requirement often resulted in bureaucratic delays. According to industry insiders, applications for loan approvals faced repeated queries, unclear procedural requirements, and limited transparency in regulatory responses. As a result, foreign-owned companies found themselves constrained in accessing the credit needed to scale their operations.

In a long-awaited move, central bank issued a circular very recently, permitting the use of foreign currency deposits held in OBUs as collateral for financing in local currency by Domestic Banking Units (DBUs). The new policy aims to streamline collateralized finance for foreign-owned companies and address longstanding regulatory bottlenecks.

The central bank’s circular outlines specific conditions under which this facility can be availed. Theses are – (a) A written request shall be submitted by the depositor authorizing the use of the deposit as collateral. (b) OBUs shall ensure a legitimate relationship between the account holder and the loan applicant. This includes relationships such as: non-resident Bangladeshis (NRBs) and their beneficiaries, foreign shareholders and their local investee companies, etc. (c) The collateral can be used only for short-term working capital loans in local currency extended by DBUs. Banks may apply a margin to mitigate exchange rate risk and but no charges fees are payable for the respective collateral. All lending must adhere to prevailing credit norms, internal risk guidelines, and regulatory safeguards.

Previously, under the foreign exchange regulatory framework, lending to non-residents against foreign currency deposits required prior permission from central bank. The new circular waives these requirements for DBUs lending in Taka, provided the collateral is held within OBUs.

Furthermore, in the event of default, the lender bank is empowered to liquidate the collateralized foreign currency deposit. OBUs must then transfer the liquidated amount to DBUs, which will report it accordingly: (a) as wage remittance in case of NRB-linked accounts, (b) as equity investment for non-NRBs, as per FDI regulations, (c) as loan proceeds, depending on the contractual arrangements. Where future repayments are involved in foreign currency, funds may be credited back to OBU accounts with approval from the central bank.

The circular also expands the scope of eligible collateral. In addition to OBU-held deposits, balances in private foreign currency accounts and non-resident foreign currency deposit accounts maintained with DBUs can also be used as collateral for short-term working capital loans. However, deposits held in International Banking (IB) accounts maintained with OBUs - used primarily for remittance facilitation - are explicitly excluded from this facility.

Industry insiders have acclaimed the central bank’s decision, calling it a 'game changer' for Bangladesh’s investment climate. By unlocking offshore deposits as collateral, the policy effectively lowers entry barriers for foreign investors and improves credit accessibility.

Experts believe the move will significantly boost foreign direct investment, particularly in capital-intensive sectors that require working capital as post-equity support. The policy is also expected to improve Bangladesh’s ranking in the global 'Ease of Doing Business' index by simplifying financing procedures for foreign-owned firms.

Stakeholders have also suggested that Bangladesh should model its OBU framework on successful case studies like Malaysia and the Philippines, where offshore banking plays a pivotal role in attracting capital inflows and enhancing financial sector depth.

While the new policy on deposit-based collateral is a welcome step, experts argue that more can be done. For example, foreign shareholders may also offer external guarantees - such as: bank guarantees and standby letters of credit (SBLCs) issued by reputable foreign banks, corporate guarantees from parent companies, etc. These instruments are often credit-rated and enforceable under international laws, providing banks with secure fallback options in case of default. However, current regulations in Bangladesh still require central bank approval for using such instruments.

To enhance access to financing and streamline cross-border lending, it is expected that central bank should introduce a policy framework for accepting such external guarantees - without requiring case-to-case approvals - provided that risk mitigation safeguards are in place.

In the evolving landscape of global finance, regulatory agility is key to sustaining investment flows. Central bank’s recent circular allowing the use of offshore deposits as collateral for local lending marks a significant shift in policy. It not only addresses long-standing challenges faced by foreign-owned businesses but also signals a broader commitment to improve the investment climate.

As Bangladesh is going to be graduated from LDC status and aspires to attract diversified capital flows, the time is ripe for further reforms. Accepting external guarantees under a defined policy framework would be the next milestone in enabling foreign participation in Bangladesh’s financial ecosystem.

 
Mehdi Rahman works in the development sector. He also 
writes on foreign trade
and monetary issues.