With the fraudulent letter of undertaking (LoU) scam aggregating ₹12,600 crore at Punjab National Bank shaking the banking system, the Reserve Bank of India on Tuesday asked banks to discontinue issuance of LoU/Letter of Comfort (LoC) for trade credits for imports into India with immediate effect.
An LoU is a document whereby the issuing bank guarantees its customer’s payment obligation to an overseas supplier. A letter of comfort is typically provided by a bank to assure the financial soundness of its customer to repay its debt. 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.
An LC ensures that a bank honours the financial obligation of a buyer if he fails to pay the seller. A bank guarantee is a kind of surety given by a bank to a third party on behalf of its customer, assuring the beneficiary that it will effect payment on default of obligation.
A senior banker said, “For import of rough diamonds, big suppliers accept only advance remittance. The issue of LoU for import of pearls in large quantity in the PNB case was rather unusual. Before the PNB episode came to light, I never came across the gem and jewellery trade resorting to LoU/LoC for trade credit.”
Two officials at PNB’s Brady House branch in Mumbai issued LoUs without authorisation to firms linked to diamantaires Nirav Modi and his uncle Mehul Choksi. Indian banks in Hong Kong paid the ‘suppliers’ of these firms based on the LoUs. The fraudulent issuance of LoUs came to light when one of the branch officials asked the firms associated with the diamantaires to furnish at least 100 per cent cash margin for issuing LoUs.
While the firms said they had been availing themselves of this facility in the past too, a check of the branch’s records did not reveal details of such facility granted to them.