RBI forbids banks from issuing Lous
TOUGH MEASURE Move may deal a blow to trade financing
MUMBAI: The Reserve Bank of India (RBI) on Tuesday barred banks from issuing letters of undertaking (Lous), the instruments used by Nirav Modi and Mehul Choksi to defraud Punjab National Bank (PNB), in a move that may deal a blow to trade financing in India and raise credit costs for importers.
RBI also barred lenders from issuing letters of comfort (LOC) as trade credit for importing goods into India with immediate effect. It, however, allowed banks to continue to issue letters of credit and bank guarantees.
The central bank’s move is likely to lead to a freeze in trade financing activities in India, increasing costs for importers who have relied on these instruments to get cheaper overseas credit to pay suppliers. It will also put companies that have received credit based on Lous in a spot, as they have to now repay their borrowings since there will no rollover of existing Lous.
Importers prefer taking loans based on Lous as they are denominated in foreign currency and are cheaper than rupee credit. A letter of credit, on the other hand, is used to establish the credit worthiness of the buyer in the purchase of goods.
“Lous and Locs don’t come under a normal credit sanction. It has been understood as giving Letters of Undertaking, or Lous, have come under the scanner after Nirav Modi fraudulentl ly obtained such credit guarantees from state-run n Punjab National Bank to avail overseas loans.
LOU is a guarantee issued by Indian banks against which a foreign currency loan is availed
LOU is used by a bank’s customer to avail short-term credit in a foreign country and used by bbusinesses to import goods
The borrower approaches a bank’s forex department in India and the bank seeks collateral, after which the LOU is issued to obtain foreign currency loans from an overseas bank
Post the ban on issuance of LOU/LOCS by RBI for trade credit, companies have the option of using bank guarantees to raise buyers’ credit, based on a sanctioned limit
just a letter. In the case of PNB, it looks like bank officials issued these instruments without proper credit assessment,” said R Gandhi, a former deputy governor of RBI.
Lenders will have to look at alternative instruments like bank guarantees. “Banks are now exploring alternative instruments like bank guarantees which are typically used as a guarantee to raise loans from other banks,” an official with a private sector bank said, requesting anonymity.
Lous and Locs are used widely in several industries including gems and jewellery, oil and gas, electronic goods, solar panels and metals. Ajay Sahai, director gen-
eral at lobby Federation of Indian Export Organisations, however, said, RBI’S move will have only a limited impact.
“I see only limited impact of the RBI directive because gems and jewellery sector was the main sector availing Lous/locs. That, too, was limited to major players. As far as other sectors are concerned, they have alternative instruments in the form of bank guarantees,” said Sahai.
Until the PNB fraud surfaced, buyers’ credit was seen as a safe business because of its shortterm nature and the risk of default was essentially on another lender. That apart, it provided the Lou-issuing bank with a source of fee income.