The recent Punjab National Bank's £1.27 billion fraud has reportedly prompted the Reserve Bank of India to ban the use of letters of undertaking (LoUs) and letters of comfort (LoCs). Both of them are instruments issued by Indian banks to domestic importers to get foreign exchange from overseas banks at a cheaper rate. The RBI issued the directive almost a month after it was brought to light that diamond merchants Nirav Modi and Mehul Choksi had misused LoUs issued by PNB to defraud the bank of over $2 billion.
An LoU is a type of guarantee between two banks that allow the issuer bank's customer to get foreign exchange from another Indian bank's foreign branch in the form of short-term credit. Bankers said the RBI decision could potentially push up the cost of imports by up to half a percentage point, other than putting foreign banks on an even keel with Indian banks in financing imports. Joiel Akilan, ED and chief representative-India of BBVA, one of Europe's leading banks, said, “This regulation will certainly help global banks that were earlier outpriced by Indian banks, to get back to financing genuine trade finance transactions of Indian corporates and support Indian imports, though withholding tax would add to the cost of the importers.”
The directive is effective immediately, however, a notification from RBI said, “Letters of credit and bank guarantees for trade credits for imports into India may continue to be issued subject to compliance with” existing regulations.
