After PNB scam, RBI discontinues LoUs and LoCs for trade credits

PNB fraud case RBI discontinues system of issuing Letters of Undertaking system

The apex bank in its notification said,"It has been chose to discontinue the practice of issuance of LoUs/ LoCs for Trade Credits for imports into India by AD Category -I banks with immediate effect". A letter of comfort is typically provided by a bank to assure the financial soundness of its customer to repay its debt.

"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", said Joiel Akilan, ED & chief representative-India of BBVA, one of Europe's leading banks.

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. They did not have any pre-approved credit limit either. It is used (by the importer) to pay for the imports into the country.

In what has been dubbed as the biggest fraud in India's banking history, the nation's second-biggest state-run lender, said last month it had been defrauded of about $2 billion by two jewellery groups who raised credit from overseas banks based on fraudulent guarantees issued in collusion with rogue PNB staff.

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An LoU is provided against a margin or a collateral which could be in the form of a fixed deposit. On the other hand, an LoC is an instrument which is similar to an LoU, except that it is an intra-bank transaction.

State-owned PNB has reported fraudulent issuance of LoUs/ Foreign Letters of Credit (FLCs) for payments of import bills, amounting to Rs 12,967.86 crore, to the RBI, Minister of State for Finance Shiv Pratap Shukla said in a written reply to the Rajya Sabha. The payment can also be made directly to the importer.

According to an RBI notification, the move will come into effect immediately.

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