Lenders, borrowers seek clarity on RBI’s ban on issuance of letters of undertaking

BANKS ARE IN TALKS WITH BORROWERS WHOSE LETTERS OF UNDERTAKING ARE MATURING THIS WEEK

MUMBAI: Confusion reigned as banks and borrowers tried to understand the implications of Reserve Bank of India’s (RBI’s) latest circular that barred the issuance of letters of undertakings (LoUs) and worked on ways to chalk out funding and repayment strategies.

Banks have also sought clarification from RBI on alternative instruments to replace LoUs to fund companies trying to import goods into India, said two bank officials, requesting anonymity.

The banking regulator’s decision to ban LoUs follows the discovery of a $2 billion scam at Punjab National Bank, which involved jeweller Nirav Modi and his uncle Mehul Choksi fraudulently obtaining LoUs from the bank with the help of rogue employees.

To start with, banks are in talks with borrowers whose LoUs are maturing this week. LoUs are guarantees issued by Indian banks against which a foreign currency loan is availed. According to Kotak Institutional Equities, India had $86 billion of trade credits, which included LoUs issued in 2017. Of the total, $56 billion was for loans between six months and one year and $30 billion for less than six months. A standard LoU is typically rolled over multiple times to help borrowers repay earlier dues. With RBI putting a stop to these instruments, borrowers may have to look to borrow locally to repay the maturing LoUs.

“Banks have the option of sanctioning fund-based rupee credit to importers, so that they can honour the maturing LoUs since they can’t be rolled over. This could be a temporary measure. That apart, borrowers can avail credit through LCs (letters of credit) and BGs (bank guarantees), which are used globally. But over time, borrowers also have the option to move to other sources of foreign funding such as ECBs (external commercial borrowings),” said Ashutosh Khajuria, executive director and chief financial officer, Federal Bank. In the long term, companies borrowing with the help of LoUs can also look at taking bilateral credit from overseas branches of Indian banks or foreign banks or branches at GIFT city to fund future imports.

Industry bodies are, however, not too happy with RBI’s move as it will impact both trade finance and currency movement.

“Because of the spurt in spot demand for dollars for importers to fulfil their obligation in currency market may go haywire,” said Anil Khaitan, president, PHD Chamber of Commerce and Industry.