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How Bangladesh factory financing actually works — and why it is a sourcing risk nobody talks about

Bangladesh garment factories do not generally operate on their own cash reserves. They operate on credit — specifically, on working capital facilities provided by local commercial banks, tied to the back-to-back letter of credit system that underpins most Bangladesh garment export. Understanding this financing structure is not a technical detail. It is the key to understanding why factories fail mid-production, why some factories take subcontract work when they should not, and why a clean compliance audit gives you no information about whether a factory can financially complete your order.

In fifteen years of operating inside this market, I have watched this system work and I have watched it fail. The 2022 incident that led to Bengal Origin Co. was, at its root, a factory financing failure. This article explains the system so that European buyers can understand the risk and ask the right questions.

The back-to-back LC system explained

When a European buyer places an order with a Bangladesh garment factory, the buyer typically issues a Letter of Credit (LC) through their European bank. This master LC commits the buyer's bank to paying the factory upon shipment and presentation of compliant documents. It is the foundation of the transaction — the financial instrument that tells the factory: this order is funded.

The Bangladesh factory then takes this master LC to its local commercial bank and uses it as collateral to open what is called a back-to-back LC. This secondary LC is issued by the factory's bank in favour of the fabric mills and trim suppliers who will provide the raw materials for the order. The factory does not pay for fabric out of its own cash. It borrows against the buyer's payment commitment.

This makes commercial sense. Garment manufacturing is a capital-intensive, order-driven business. A factory producing 50,000 garments needs to purchase fabric, thread, buttons, zippers, labels, and packaging — all before a single garment is shipped and paid for. The back-to-back LC system allows factories to operate with relatively low equity because the buyer's payment commitment provides the security the bank needs to extend credit.

The system has enabled one of the largest garment export industries in the world. Bangladesh exports over $40 billion in garments annually, and the back-to-back LC system finances the vast majority of that production. But the system creates specific vulnerabilities that European buyers almost never see — until something goes wrong.

Where the system breaks down

The back-to-back LC system has several stress points, any of which can cause a factory to fail mid-production even when the buyer's order is fully funded.

Bank credit withdrawal. If a factory's bank reduces or withdraws its working capital facility — due to the factory's deteriorating credit position, broader bank lending restrictions, or Bangladesh Bank (central bank) policy changes — the factory loses the ability to open back-to-back LCs. Without back-to-back LCs, it cannot purchase raw materials. Orders already in production may stall because fabric for subsequent production lots cannot be procured. The buyer's master LC is still valid. The buyer's payment commitment still exists. But the factory physically cannot execute the order because its bank will not finance the raw materials.

Overextension. A factory that has committed to more orders than its credit facility can support will face a prioritisation problem. The bank grants a working capital limit — say, $5 million. If the factory has accepted orders requiring $7 million in raw material purchases, it cannot open back-to-back LCs for all of them simultaneously. It must choose. Invariably, the factory prioritises the buyers it cannot afford to lose — large volume, long-term customers who represent the majority of the factory's revenue. Smaller orders, trial orders, and orders from newer buyers are deprioritised. The buyer does not know this is happening. They simply experience delayed fabric sourcing, missed timelines, and eventually late delivery.

Currency pressure. Bangladesh taka depreciation against USD — the currency in which most fabric is priced — increases the local currency cost of imported fabrics and trims. When the taka weakens, a factory's existing credit facility buys less raw material than it did when the order was costed. This compresses margins and can create cash flow pressure even when orders are executing normally. Factories under currency pressure may delay fabric purchases, hoping the taka will recover, or may seek cheaper substitutes that may not meet the buyer's specifications.

What factory financial stress looks like before it becomes a crisis

Factory financing problems do not appear overnight. They develop over weeks and months, and they produce visible signals before they produce missed shipments. The challenge is that most European buyers are not looking for these signals — and most buying houses are not structured to detect them.

Utility payment delays. Factories under financial stress frequently fall behind on electricity and gas bills before they fall behind on orders. Utility providers in Bangladesh are more tolerant of delayed payment than fabric suppliers, so utilities are the first obligation that slips. A factory that is behind on utilities is under cash pressure.

Wage payment timing shifts. In a healthy factory, wages are paid on or around the 7th of the month. When a factory's financial position deteriorates, wage payments begin shifting later — to the 12th, then the 18th, then the 25th. This is a progression that signals deteriorating cash position. Workers notice it immediately. Buyers typically never know.

Subcontract work appearing. A financially stressed factory will take subcontract work from other factories to generate quick cash flow. Subcontract work — sewing garments cut and kitted by another factory — pays faster and requires less capital outlay than original orders. When a factory that normally runs only its own buyers' orders begins taking subcontract work, it is generating cash to cover operational costs that its normal order flow cannot fund. This is visible if you ask the right questions: is this factory running any subcontract work currently? If yes, how much of production capacity is allocated to it?

Management departures. Senior production managers and finance managers leaving a factory is a leading indicator of financial stress. These managers typically have better information about the factory's real financial situation than external buyers or buying houses do. When the people running the operation decide to leave, they are acting on information that has not yet reached the market.

How this connects to the subcontracting problem

When a factory loses the ability to purchase raw materials for an in-progress order, it faces a binary choice. It can disclose the problem to the buyer and the buying house — which means admitting financial difficulty and almost certainly losing the business relationship. Or it can take subcontract work to generate cash, hope that the financial situation improves, and attempt to complete the original orders with a delay.

Most factories choose the second option. This is not always dishonest — sometimes factory management genuinely believes they can recover the situation. But the result for the buyer is an order that goes quiet, misses its midpoint, and eventually either delivers very late or does not deliver at all. The subcontract work keeps the factory's lights on and workers employed. The buyer's order effectively subsidises this survival — not through their payment, but through the production capacity that should have been allocated to their garments.

A written subcontracting prohibition — which we require on every order at Bengal Origin Co. — does not prevent a factory from making this choice. What it does is make the factory legally and contractually accountable if they do. The documentation creates a clear record that the factory agreed not to subcontract, making any breach unambiguous. But the underlying financial stress is the root cause. The prohibition treats the symptom. Financial vetting treats the disease.

What buyers can do to assess factory financial health

European buyers are not powerless here. Several practical steps can surface factory financial risk before it becomes a production crisis.

Request a bank solvency certificate. This is a formal document from the factory's bank confirming that the factory has an active and current working capital facility. It does not disclose the amount of the facility or the factory's credit utilisation — it simply confirms that the banking relationship is active and the factory has access to working capital. Most serious factories will provide this document. A factory that refuses should raise questions about why.

Ask about current order book utilisation. A factory running above 90-95% capacity is financially exposed even if its credit is fine — because any production disruption, quality issue, or fabric delay will cascade across all orders with no buffer. The healthy range is 60-85%. Below 40% suggests the factory is not covering fixed costs, which creates its own form of financial pressure.

Ask specifically about the back-to-back LC situation for your order. Who is the bank? Has the back-to-back LC been opened? What is the fabric purchase status? These are operational questions that a legitimate factory and buying house should be able to answer clearly. Vagueness in response to these questions often indicates that the LC process has not progressed as expected.

Why buyers do not ask these questions

Most European buyers are not aware that factory financing is something they should be monitoring. The Bangladesh sourcing market presents itself as a straightforward supplier relationship — you send a tech pack, the factory quotes, you confirm, they produce, you pay. The financing infrastructure that underlies every step of this process is invisible unless something goes wrong.

This is not a criticism of factories. The back-to-back LC system has enabled Bangladesh to become the second-largest garment exporter in the world. It has lifted millions of workers out of poverty and built a globally competitive manufacturing sector. But it is a system that creates specific risks that are structurally different from sourcing in, say, Turkey or Portugal, where factories typically operate with higher equity ratios and less dependence on bank credit for each individual order.

Understanding this difference is not about being suspicious of Bangladesh factories. It is about being informed enough to ask the right questions and interpret the answers correctly.

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The 2022 failure that led to Bengal Origin Co. was a back-to-back LC problem. A factory's bank withdrew its credit facility mid-production. The factory took subcontract work to cover costs. Three orders failed. None of it showed up in the compliance audit that had run six months earlier. We now check bank solvency as a condition of factory onboarding — and monitor it every six months. That protocol exists because we understand how the system works.