By Suranjana Roy
India took a major blow when the Nirav Modi-led Punjab National Bank (PNB) scam first hit the national headlines. Shook to its core, the Reserve Bank of India (RBI) decided to take stringent measures to initiate yet another layer of checks and balances over the national banking and monetary policy. In a recent circular dated 13th March 2018, the RBI, with immediate effect, has decided to discontinue the issuance of Letters of Undertaking (LoUs) as well as Letters of Comfort (LoCs) for trade credits for imports into India. It also stated that “the Letters of Credit will continue to be issued, subject to compliance with the provisions contained in the Department of Banking Regulation Master Circular on ‘Guarantees and Co-acceptances’ dated July 1, 2015.”
What are LoUs and LoCs?
Commercial banks are facilitators of trade, using mechanisms to ease the same. Thus, Letters of Undertaking, Letters of Comfort and Letters of Credit play an important role, especially in the sphere of foreign trade. A Letter of Undertaking is an undertaking provided by one bank to another, on behalf or favour of its customer. It is essentially a promise the bank makes to complete the terms and conditions of a transaction that its customer undertakes. LoUs are thus used by customers to obtain short-term credit from a foreign bank, mostly for businesses that import goods.
A Letter of Comfort runs on similar lines; it is an assurance of the customer’s financial soundness to repay the debt. Letters of Credit are also inter-bank issuances to guarantee payments of a specified person. “An authorised dealer may give a guarantee, letter of undertaking or letter of comfort in respect of any debt, obligation or other liability incurred by a person resident in India and owned to a person resident outside India (being an overseas supplier of goods, bank or a financial institution), for import of goods, as permitted under the Foreign Trade Policy…,” the RBI had said in its directives for import of goods and services.
In context, PNB had allegedly issued many fraudulent LoUs to millionaire diamond merchant Nirav Modi and some other jewellers as well. Investigations show that Modi sought LoUs to raise credit from foreign banks to pay for the imported raw materials. It was found out that two employees of PNB fraudulently issued LoUs without following the standard procedures and also never entered them in the banking records, to avoid detection. Instead of raising cash and settling the dues, Nirav Modi did nothing to repay his loans. This has led to fraudulent transactions worth Rs 11,400 crores.
What will happen next?
The current circular discontinues the issuance of LoUs for trade finance by Authorised Dealer (AD) Category-1 banks. AD Category-1 banks are authorised by the RBI to deal with the conversion of currency notes, coins or travellers’ cheques designated in foreign currency into Indian Rupees and vice versa.
All this means that the future of importers and imports, as a business, is going to be extremely rough. Details are still not known as to how this will affect the nation’s ever-booming international trade but time will tell soon. As of now, the loopholes in the structural banking system are a testimony to the inefficiency plaguing the economy and it is only the reformed governance of the RBI that can improve the situation.
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