Ban on LoUs by RBI will have disruptive impact, raise cost of credit: CII

Industry bodies on Wednesday said RBI's decision to ban Letters of Undertaking (LOUs) for trade credit for imports will have a disruptive impact, at least in the immediate term, as small businesses would require higher working capital.

In a significant development, the RBI on Tuesday barred banks from issuing guarantees in the form of LoUs and letters of comfort in the wake of nearly $2 billion scam in state-run Punjab National Bank involving jeweller Nirav Modi and his uncle Mehul Choksi.

Ajay Sahai, Director General of exporters' body FIEO opined that RBI's move will have limited impact as LoUs are generally used in gems and jewellery sector and that too by large players.

In a statement, CII President Shobana Kamineni said the move would have a "disruptive impact" on the buyers' credit market, in the immediate term.

"The traders who have been conducting business through these two instruments will now have to necessarily shift their transactions to Letters of Credit and bank guarantees," said Kamineni.

PHD Chamber President Anil Khaitan said banning of these instruments is not a solution to curb malpractices or scandals.

"We know that this move by RBI would result into increasing working capital requirement of industries as per their trade cycle and will disrupt trade, services and industry," said Khaitan.

"Industry, particularly MSMEs whose working capital is based as per their trade cycle, will require higher working capital or else suffer irreparable losses," he added.

While RBI has banned LoUs and letters of comfort, letters of credit and bank guarantees will remain available for trade credit.

PNB reported fraudulent issuance of LoUs/ Foreign Letters of Credit for payment of import bills and fraudulent transactions in accounts, amounting to Rs 129.67 billion, to RBI through its fraud monitoring reporting system.

A multi-agency probe, including by CBI and ED, has been launched into the PNB fraud.