Parliamentary Panel Suggests Restoring LoUs Banned After PNB Fraud

A parliamentary panel suggested that the letters of undertaking/comfort should be restored, and the Reserve Bank of India’s move to ban such guarantees after the fraud at Punjab National Bank was a “knee-jerk” reaction.

Issuance of LoUs/LoCs should be restored with proper safeguards, said a report by the Parliamentary Committee on Commerce headed by Rajya Sabha member Naresh Gujral. Necessary steps should also be taken to simplify and streamline the processing of letters of credit—another such instrument that wasn’t banned—according to the report presented in Parliament today.

These guarantees are used by importers to borrow overseas to fund imports. The central bank had banned LoUs/LoCs after PNB informed exchanges in February that jewellers Nirav Modi and Mehul Choksi had allegedly secured fraudulent LoUs in connivance with some of the employees at a Mumbai branch of the bank.

After the ban, most banks reduced their exposures to these instruments by over 75 percent, the report said. Export credit too declined 24.4 percent in the 2017-18 financial year and was down 29.6 percent year-on-year in 2018, the committee said. This slide along with discontinuance of LoU/LoCs will impact exports adversely, the panel said, adding that the issue “deserves immediate attention in order to avert likely disruption to trade and industry”.

According to the parliamentary committee report, the central bank said it was advised by Foreign Exchange Dealers’ Association of India to discontinue LoUs/LoCs as there was neither a standard format nor a standard protocol, like the one prescribed by the International Chambers of Commerce for letters of credit or documentary credit. However, representatives of public and private sector banks, many of whom were FEDAI members, told the parliamentary panel that LoUs/LoCs were an effective instrument for raising short-term credit in foreign currency. All banks unanimously accepted that they were not flawed, the report said. “Instead, these were means of raising cheaper finance for trade.”

The banks told the panel that the fraud at PNB was localised to only one branch and was perpetuated by one family.

The Department of Financial Services had sought comments from the central bank on the impact of discontinuing LoUs/LoCs on credit costs of short-term foreign currency loans. The RBI, according to the parliamentary panel, said there was no comparative reporting on the quantum or cost of trade finance through LoUs/ LoCs against other available avenues.

The department, on March 6, also urged the central bank to consider the need to continue LoUs, especially since an option like a letter of credit was governed by a set of rules issued by International Chamber of Commerce, Paris, and was already available for supporting international trade.

“The committee strongly feels that the RBI has perhaps not held enough consultations before deciding to discontinue issuance of LoU/ LoC,” the parliamentary panel’s report said.

SBI’s Alternative

The State Bank of India, according to the panel, has come up with an alternative instrument that could be as cost effective and accessible for importers as LoUs/LoCs.

It’s a reimbursement product with systemic and compensatory controls which is being extended to AAA and AA-rated large corporates, it said. Over six months, it will be extended to small and medium borrowers as well.

The panel suggested that SBI must ensure that SME borrowers are not left out, and hoped other banks also come up with products that provide similar benefits as LoUs/LoCs.