RBI bars issuance of letters of undertaking for trade credit

Marco Green
March 13, 2018

The issuance of LoUs as a guarantee for credit, has come under fire since the instrument was grossly misused in perpetuating the biggest bank fraud in recent history. Both Modi and Choksi have fled the country. Police say they left India in January, before the initial complaint was filed, and their whereabouts are unknown.

"On a review of the extant guidelines, it has been made a decision 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 central bank said in a notification. It said banks could continue issuing credit guarantees in the forms of letters of credits and bank guarantees, however, if certain parameters were met.

The 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. A letter of comfort is typically provided by a bank to assure the financial soundness of its customer to repay its debt. The current exposure takes the overall amount in the Nirav Modi scam to around Rs 13,400 crore.

A lawyer for Choksi said he was unaware of the new allegations and declined to comment. Choksi's Gitanjali Group defrauded Rs 7,080.86 crore while the rest is attributed to companies of Modi.

PNB did not immediately respond to requests for comment.

Noting that the RBI has instructed banks to "strengthen their SWIFT operating environment", Shukla said the central bank has also constituted an expert committee to look into factors "leading to increasing incidence of frauds in banks and the measures (including information technology interventions) needed to curb and prevent it, and the role and effectiveness of various types of audits conducted in banks in mitigating the incidence of such frauds".

State Bank of India and three other state-run banks, Union Bank of India, UCO Bank and Allahabad Bank, are among lenders who have extended credit based on the LoUs issued by PNB that were later found to be fraudulent.

PNB has said it will honour only "bona fide" commitments, arguing other banks that lent to the jeweller groups shared in the blame by not carrying out adequate checks.

"While settling the dues, PNB will issue a letter to counter banks that they would be liable to make good the payment if the findings by the investigative authorities prove that there was malafide intent on the part of peer banks", said one of them.

"The rate may go up by at least 70-120 basis points because the inter-bank market will dry up and not all banks have access to sufficient dollar liquidity", said Gupta.

During issuance of LoU, there are four parties involved - issuing bank, receiving bank, importer and beneficiary entity overseas.

Other reports by Click Lancashire

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