Discontinuation of LoU/Buyer's Credit

The Reserve Bank of India has decided in the month of March-2018 to discontinue issuance of letters of undertaking (LoU) and letters of comfort (LoC) for trade credit for imports into India. Authorised dealer-1 (AD-1) category banks will not be allowed to issue LoCs and LoUs for this line of business, the regulator said in a notification on its website. Banks may continue to issue letters of credit and bank guarantees for trade credit for imports into India as per the current guidelines applicable, the notification added.This is part of a series of moves from the RBI after details of the Nirav Modi scam came to light. In the case, Nirav Modi’s associates approached the domestic branch of Punjab National Bank to issue fraudulent LoUs to foreign branches of other Indian banks through the SWIFT network. These LoUs were not registered in the core banking system for PNB. This means that the bank was virtually unaware of any such transactions taking place. The difference between these products is that LoUs and LoCs were issued by domestic banks at the behest of the importer. The importer would negotiate the right price for these loans from the foreign branches of other Indian banks and then get these letters issued by a domestic bank. The exporter, or seller, would be paid from the nostro account.In the case of letters of credit and bank guarantees, domestic banks issue these in favour of the exporter, or seller’s, bank. Typically in these transactions, the seller would take the foreign exchange cost and would build that into the price of the product. LoUs in itself were a good product and the fraud at PNB was more of a systemic issue. Banking industry is having inherent risk like other segments. Hence Govt/RBI/Banks are required to ensure that transaction happening through any window is genuine rather than closing the window for always. Domestic buyer has to arrange for rupee or foreign currency funds to make the payment on the due date which actually was going to take place after 1 or 3 year.It would not only increase liquidity problems to domestic players but would come with other problems also.