However, letters of credit and guarantees would continue to be issued like before if they meet certain criterion
Anup Roy | Mumbai Last Updated at March 13, 2018 21:08 IST
The Reserve Bank of India (RBI) on Tuesday discontinued issuance of letters of undertakings (LoUs) and letters of comforts for importers with immediate effect, possibly in a bid to prevent frauds such as the one allegedly carried out by jewellers Nirav Modi and Mehul Choksi. However, letters of credit (LC) and guarantees would continue to be issued like before if they meet certain criterion. Normal trade credit is unlikely be hampered. Banks have cut down on issuance of LoUs after the news of Punjab National Bank getting defrauded Rs 127 billion through these instruments came to light. While all are essentially guarantees, there are subtle differences and provisioning requirement also vary. A letter of comfort is issued by a party (in this case bank) to other banks certifying the financial soundness of the transaction of firm. In the case of a LoU, the bank is virtually guaranteeing that if the party doesn’t pay up, the bank will step in with payment. A letter of credit, on the other hand, is based on solid documentations and only after the bank is sure about the genuineness of the transactions are payments made. Essentially, in the case of LoUs and LoCs, the bank is guaranteeing the genuineness of the trade or the party, whereas in case of LCs, the bank is issuing the document against a transaction that has happened but payment has not gone through.
Bank guarantees are a promise from a bank that if a party defaults, the bank will cover the loss. In the Nirav Modi scam, LoUs were issued by a few PNB staff bypassing the bank’s core systems. The original size of the scam was determined at Rs 114 billion, but has increased with further investigation. The RBI on Monday had reduced the tenure of guarantees and standby LC to one year, from three years earlier and had said banks should ensure that these SBLCs/guarantees are used by their clients for the intended purposes only. It had also modified its guidelines on hedging of commodity risks, but did not extend the facility to firms trading in gold, gems and precious stones. Even as the RBI has allowed LCs and guarantees, the guidelines said banks should not take too much of an unsecured exposure. LCs are issued in serially numbered security forms, and there is a clause for the beneficiaries that “they should, in their own interest, verify the genuineness of the guarantee with the issuing bank.” There are also strict criterion for bank guarantees, such as any guarantee issued for Rs 50,000 and above should be signed by two officials jointly. A lower cut-off limit is also followed by some bank branches. “The responsibility for ensuring the adequacy and effectiveness of the systems and procedures for preventing perpetration of frauds and malpractices by their officials would, in such cases, rest on the top managements of the banks,” the RBI’s master circular says. “In case, exceptions are made for affixing of only one signature on the instruments, banks should devise a system for subjecting such instruments to special scrutiny by the auditors or inspectors at the time of internal inspection of branches,” according to RBI norms.
First Published: Tue, March 13 2018. 21:08 IST