PNB effect: RBI ends LoUs, LoCs with immediate effect

The RBI said the decision to discontinue the practice of LoUs and Letters of Comfort for trade finance comes into force with immediate effect. Reutrs File

The RBI said the decision to discontinue the practice of LoUs and Letters of Comfort for trade finance comes into force with immediate effect. Reutrs File

"On a review of the extant guidelines, 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", RBI said in a notification on Tuesday.

"Letters of credit and bank guarantees for trade credits may continue to be issued subject to compliance with the regulations".

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.

Fraud-hit Punjab National Bank (PNB) has taken a series of measures to check misuse of Swift message platform, allegedly used by Nirav Modi and his associates to defraud the bank of Rs 1,2967.86 crore, the Finance Ministry said on Tuesday. Moreover, the buyer's credit raised was not used for specific purposes in many cases.

Thus, the earlier master circulation of RBI said, "Banks should not extend any non-fund based facilities or additional/ad-hoc credit facilities to parties who are not their regular constituents, nor should they discount bills drawn under LCs, or otherwise, for beneficiaries who are not their regular clients".

The report quotes PNB General Manager Ashwini Vats who wrote in a response to Modi, saying, "You are aware of the amount of fraud committed by you and yet you propose to pay a paltry amount with no proposal or ability to pay the remaining amount".

As of now, under the RBI's policy on trade credits for imports, authorised dealer (AD) banks were allowed to issue guarantees - LoUs or LoCs - in favour of overseas supplier, bank, and financial institution, up to $20 million per transaction for a year.

An LoU is provided against a margin or a collateral which could be in the form of a fixed deposit.

"LoU was an additional route availed by Indian importers". On the other hand, an LoC is an instrument which is similar to an LoU, except that it is an intra-bank transaction.

The RBI has already started a special audit of public sector banks wherein it will closely scrutinise their trade financing activities especially with regards to the issuances of LoUs. The payment can also be made directly to the importer.

After the unearthing of the PNB fraud, an RBI notification last month said: "The risks arising from the potential malicious use of the SWIFT infrastructure has always been a component of their operational risk profile".

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