After Punjab National Bank fraud, RBI stops use of Letters of Undertakings for trade credit finance

MUMBAI: A month after the $2-billion PNB fraud surfaced, the Reserve Bank of India (RBI) seems to have run out of road. In an unexpected move on Tuesday, it discontinued issuance of Letters of Understanding (LoUs) for imports into India with immediate effect.

Existing LoUs will be honoured, while letters of credit and bank guarantees may continue to be issued subject to compliance with norms.

The move scrapping LoUs – a direct fallout of the PNB fraud – jackknifes between a kneejerk reaction by RBI and the sector’s inability to fix the flaws that are beyond repair.

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Sources said it could impact inter-bank credit, increase rupee borrowings, and worsen balance sheets of both banks and firms dependent on imports, besides denting the credibility of the entire bank payment mechanism.

The extent of outstanding LoUs by all banks couldn’t be immediately ascertained as the central bank only recently sought this information from lenders. But, RBI’s slapdash move scrapping them altogether is perhaps indicative of the instrument’s underlying misuse. Finance Minister Arun Jaitley said in Parliament on Tuesday that Nirav Modi has obtained 1,213 LoUs in over 74 months from PNB.

LoUs – instruments where a bank allows customers to raise short-term foreign currency from its own or another bank’s foreign branch to repay offshore suppliers – were allegedly used by absconding jewellers Modi and Mehul Choksi to perpetrate the $2-billion PNB fraud in connivance with bank officials.

Banks are permitted to approve trade credits for imports into India up to $20 million per import transaction for up to one year for non-capital goods (except gold) and up to three years for capital goods. They have to furnish data quarterly to RBI.

Meanwhile, Reuters reported PNB disclosed additional exposure in Modi, Choksi fraud.

“In a court filing on Tuesday, police said PNB had filed a new complaint alleging it had been defrauded of an additional 9.42 billion rupees ($145 million) by the Gitanjali group of jewellery companies,” the report said.