RBI scraps LoUs, LOCs for trade credit

The Dollar Business Bureau

The Reserve Bank of India (RBI) on Tuesday scrapped issuance of guarantees in the form of Letter of Undertaking (LoU) and Letter of Comfort (LoC) by the commercial banks, with immediate effect.

The latest regulatory clampdown by the RBI came in the wake of fraud in Punjab National Bank (PNB), as the regulator tries to plug a loophole and improve due diligence in trade credit by banks. 

However, the regulator said that the Letters of Credit and bank guarantees may continue to be issued, subject to meeting certain rules.

These instruments are a forms of trade finance used by importers for funding their international purchases.

“On a review of the extant guidelines, it has been decided to discontinue the practice of issuance of LoUs/LoCs for Trade Credits for imports into India by AD Category - I banks with immediate effect,” the RBI said in a statement.

“Letters of Credit and Bank Guarantees for Trade Credits for imports into India may continue to be issued subject to compliance with the provisions contained in Department of Banking Regulation Master Circular No. DBR. No. Dir. BC.11/13.03.00/2015-16 dated July 1, 2015 on “Guarantees and Co-acceptances”, as amended from time to time,” it added.

The banking system in India is facing the biggest bank fraud with fashion jeweller Nirav Modi and his uncle Mehul Choksi of Gitanjali Gems allegedly duped PNB with around Rs.14000 crore by using the LoUs issued by the bank.

Ever since the fraud came to light, PNB, RBI and the Government have been wrangling with the issue of how to settle the liabilities arising out of this fraud. The banks who are possessing the LoUs are asking the PNB to honour these instruments, while the state-owned lender said that this was due to a chain of fraudulent transactions and other banks were also negligent in the due diligence.