The exposure of Indian banks to letters of undertaking (LoUs)/letters of comfort (LoCs) amounts to only ₹20,000-40,000 crore, according to a State Bank of India research report.
With the Reserve Bank of India banning LoUs/LoCs following the ₹12,600-crore LoU scam at Punjab National Bank, the report said the aforementioned amount, which has been in the system through credit by overseas banks/branches on the back of LoU/LoCs as hitherto, will possibly now be financed through alternative arrangements/products.
The alternative arrangements/products for providing trade credit for imports into India may be through, among others, letters of credit and financial guarantees.
“We can also say domestic credit may increase to some extent as an alternative mechanism of funding, though foreign branches may see some decline in business,” said the report titled ‘LoC Becomes LoD (Letter of Discomfort)’.
The cost of funds are expected to go up for customers who avail of LCs (LC opening charges, negotiation/collection, etc), it added.
“Overall, we believe even though guarantees are a minuscule portion of total ASCB (all scheduled commercial banks) advances — and hence, impact on credit growth may not look statistically large because of such discontinuation — there could be an increase in borrowing costs,” the report said.
The other impact of the ban on LoU/LoC could be foreign branches of Indian banks witnessing some decline in business and an increase in borrowing costs.
In terms of numbers, as per latest available RBI data, under Contingent Liabilities (Guarantees Given on behalf of Constituents Outside India) stood at ₹1.95 lakh crore as on March 2017.
Bank credit
“When we look at ASCB credit, the figure stands at ₹81 lakh crore. Guarantees outside India, if looked at as a per cent of total ASCB advances, are 2.4 per cent and this share has, in fact, reduced over the years.
“While it may be hazardous to guess the impact of abolition, nevertheless we have treaded on this path to put a number to it. Taking scenarios of 10 per cent and 20 per cent of the above (₹1.95 lakh crore), the off-balance sheet exposure in LoUs/LoCs amounts to around ₹20,000-40,000 crore,” said the report.