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It appears that the Reserve Bank of India (pictured) has advised Punjab National Bank (PNB) to honour all payments under the disputed LOUs. Strictly speaking, an LOU has no legal standing and is not governed by the Union Customs Code and the practice of the International Criminal Court. AN IOU is considered a gentleman's agreement, but gained the status of a bank guarantee, particularly when they are issued within a group, in global markets.
In India, initially LOUs were prevalent within bank branches, that is, when issued by domestic branches favouring overseas branches, usually against earmarked deposits or unused credit limits. At some point this became an interbank instrument, perhaps without RBI knowledge, in the sphere of trade credit.
It is not clear how a junior officer of PNB could have access to SWIFT for authorisation of several LOUs in collusion with another officer, and how such nonfund exposure was left out of core banking system. It is also not clear if the financing banks omitted to advise PNB while discounting bills under LOU.
The large scale fraud suggests not just failure of systems at PNB and other financing banks, but also regulatory failure on the part of RBI. A black mark against Indian financial markets.
C Chandrasekhar Mumbai
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