RBI bars issuance of letters of undertaking for trade credit

RBI bars issuance of letters of undertaking for trade credit

In a major decision that could hamper business prospects of several banks, the Reserve Bank of India (RBI) on Tuesday banned banks from issuing Letters of Undertaking (LoUs) on trade credits for imports. Bankers say the scrapping of LoU/LoC is unlikely to impact trade credit as banks can issue Letters of Credit (LC) and Bank Guarantees for trade credits for imports.

However, "letters of credit and bank guarantees for trade credits for imports into India may continue to be issued subject to compliance with" existing regulations, a notification from RBI said. A letter of comfort is typically provided by a bank to assure the financial soundness of its customer to repay its debt.

The RBI's action comes almost a month after PNB announced that it had detected fraudulent and unauthorised transactions at its Brady House branch in Mumbai. The CBI has in its two FIRs filed on the PNB scam accused that fake LoUs were issued without keeping any margin money as security. They did not have any pre-approved credit limit either.

The sector also got a boost on news that Bank of India recovered about 70 billion rupees ($1.08 billion) that had earlier been categorized as bad loans.

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The report quotes PNB General Manager Ashwini Vats who wrote in a response to Modi, saying, "You are aware of the amount of fraud committed by you and yet you propose to pay a paltry amount with no proposal or ability to pay the remaining amount".

The Bank has reported a Gross Non Performing Assets (Gross NPAs) of Rs 57519.41 Crore (12.11 % of total assets) and Net Non Performing Assets (Net NPAs) of Rs 34075.65 Crore (7.55% of total assets).

The RBI decision could potentially push up the cost of imports by up to half a percentage point, besides putting foreign banks on an even keel with Indian banks in financing imports, bankers said. A nostro account is an account held by an Indian lender in a foreign bank in their currency.

According to an RBI notification, the move will come into effect immediately. "The instrument (LoU/LoC) is being blamed, taking the focus away from the system failure in PNB", Sanjay Mandavia, an expert on trade finance who arranges buyers credit for SMEs, told The Telegraph.