After Nirav Modi-PNB scam, RBI bans LoUs, Letters of Comfort


The Reserve Bank of India (RBI) on Tuesday banned banks from issuing Letters of Undertaking (LoUs) – instruments used allegedly by jewellers Nirav Modi and his uncle Mehul Choksi to perpetrate a Rs1,400 crore fraud on the Punjab National Bank in connivance with bank officials.

The RBI also scrapped the Letter of Comfort as it attempts to plug a loophole and improve banks’ due diligence in trade credit.

Banks can continue to issue guarantees and letters of credit for trade purposes, which are the international norm and also have features that make the claim on the issuer strong.

The central bank RBI said the decision to discontinue LoUs and LoCs for trade finance comes into force with immediate effect.

”On a review of the extant guidelines, it has been decided to discontinue the practice of issuance of LoUs/LoCs for trade credits for imports into India by AD CategoryI banks with immediate effect,” the central bank said in a notification.

The banned LoUs and LoCs meant receiving banks depended completely on the issuing bank on creditworthiness. Guarantees and LoCs on the other hand involve receiving banks conducting their own credit appraisal on companies, which reduces the risk of defaults.

Doing away with these trade instruments would raise the cost of funding for companies that use them, but would increase the responsibility of banks that are lending based on these instruments.

”A letter of credit is more secure because it has the details of the purchase by the importer, date of issue, expiry date, the material purchase and other transaction details,” an executive at a state-run lender told The Economic Times. ”A LoU does not have these details and when it is not linked to the banking system it cannot be traced, like it happened with PNB.”

Punjab National Bank reported fraudulent issuance of LoUs / Foreign Letters of Credit for payment of import bills and fraudulent transactions in accounts amounting to Rs12,967.86 crore to RBI through its fraud monitoring reporting system.

Since the scandal was exposed, banks, the PNB, the regulator and the government have been bickering over how to settle the liabilities arising out of the fraud. While banks that possess the LoU say that PNB has to honour it, the state-run lender in the thick of the scam says that it was a due to a series of fraudulent transactions and others were also lax in due diligence.

A multi-agency probe, including by the Central Bureau of Investigation and the Enforcement Directorate, has been launched into the PNB fraud.

The RBI notification further said that letters of credit and bank guarantees for trade credits for imports into India may continue to be issued in compliance with the provisions.


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