 "RBI bars banks from issuing LoUs after Nirav Modi, Choksi fraud at PNB")
The Reserve Bank of India (RBI) on Tuesday discontinued issuance of letters of undertaking (LoUs) and letters of comfort (LoCs) for importers with immediate effect, in an attempt to prevent fraud such as the one allegedly carried out by jewellers Nirav Modi and Mehul Choksi.
Letters of credit (LCs) and guarantees will continue to be issued like before if they meet certain criteria.
Normal trade credit is unlikely to be hampered. However, costs would increase for importers and a profitable business avenue for foreign branches of banks would close down, said senior bankers. Importers were raising these LoUs at a cheaper rate than what they would have done had they gone in for direct dollar financing.
Another issue will be that since importers will now have to buy dollars from the market, the rupee could come under pressure.
"This would put temporary pressure on Rupee. As importers will have to buy the dollars," said K N DEY Managing. Partner of Mumbai based, United Financial Consultants.
The move is likely to hurt large importers severely. According to an importer, it used to import goods taking LoUs and LoCs from banks, while subsequently discounting them in the overseas market.
This was for the period of a normal business cycle (90 days). Discount rates are 40-50 basis points above the London Interbank Offered Rate, or Libor. Hence, importers used to secure financing at 2 per cent per annum from the overseas market. Importers would produce finished goods with the imports and square off the bank loan by selling the finished product.
A corporate treasury official estimated that the LoU discount market was at about 30 per cent of the country’s total imports. According to him, now the business risk for importers will increase because they will need higher finance limits from banks, which banks are anyway reluctant to provide.
However, Ajay Sahai, director-general and chief executive, Federation of Indian Exports Organisation (FIEO), said feedback from industry was that discontinuation of LoUs and LoCs would a have limited impact. These were mainly used by the gems and jewellery industry. The alternative means (LCs and bank guarantees) are available for accessing trade finance. Borrowers will have to see if the cost of accessing finance through these guarantees and letters of credit goes up. It will be linked to the rating of the client concerned.
LoUs and LoCs helped importers access cheap money (foreign currency) from the international market. But when converted into rupees for the purpose of accounting, the foreign exchange risk had to be factored in, bankers said.
Banks have cut down on issuance of LoUs after news of Punjab National Bank being defrauded of Rs 127 billion through these instruments.
While all are essentially guarantees, there are subtle differences. Provisioning requirements also vary.
An LC is issued by a party (in this case the bank) to other banks certifying the financial soundness of the transaction of a firm. In the case of an LoU, the bank is virtually guaranteeing that if the party does not pay up, the bank will step in with payment.
Letters of credit (LCs) and guarantees will continue to be issued like before if they meet certain criteria.
Normal trade credit is unlikely to be hampered. However, costs would increase for importers and a profitable business avenue for foreign branches of banks would close down, said senior bankers. Importers were raising these LoUs at a cheaper rate than what they would have done had they gone in for direct dollar financing.
Another issue will be that since importers will now have to buy dollars from the market, the rupee could come under pressure.
"This would put temporary pressure on Rupee. As importers will have to buy the dollars," said K N DEY Managing. Partner of Mumbai based, United Financial Consultants.
The move is likely to hurt large importers severely. According to an importer, it used to import goods taking LoUs and LoCs from banks, while subsequently discounting them in the overseas market.
This was for the period of a normal business cycle (90 days). Discount rates are 40-50 basis points above the London Interbank Offered Rate, or Libor. Hence, importers used to secure financing at 2 per cent per annum from the overseas market. Importers would produce finished goods with the imports and square off the bank loan by selling the finished product.
A corporate treasury official estimated that the LoU discount market was at about 30 per cent of the country’s total imports. According to him, now the business risk for importers will increase because they will need higher finance limits from banks, which banks are anyway reluctant to provide.
However, Ajay Sahai, director-general and chief executive, Federation of Indian Exports Organisation (FIEO), said feedback from industry was that discontinuation of LoUs and LoCs would a have limited impact. These were mainly used by the gems and jewellery industry. The alternative means (LCs and bank guarantees) are available for accessing trade finance. Borrowers will have to see if the cost of accessing finance through these guarantees and letters of credit goes up. It will be linked to the rating of the client concerned.
LoUs and LoCs helped importers access cheap money (foreign currency) from the international market. But when converted into rupees for the purpose of accounting, the foreign exchange risk had to be factored in, bankers said.
Banks have cut down on issuance of LoUs after news of Punjab National Bank being defrauded of Rs 127 billion through these instruments.
While all are essentially guarantees, there are subtle differences. Provisioning requirements also vary.
An LC is issued by a party (in this case the bank) to other banks certifying the financial soundness of the transaction of a firm. In the case of an LoU, the bank is virtually guaranteeing that if the party does not pay up, the bank will step in with payment.
