Nearly a month after the Rs 12,700 crore fraud at the Punjab National Bank (PNB) came to light, the Reserve Bank of India on Tuesday ended the Letters of Undertaking (LoUs) and Letters of Comfort (LoCs) for trade credit. The central bank’s decision came after it was alleged that diamond czar Nirav Modi obtained fake LoUs to pull-off the fraud by colluding with a former bank employee.
“On a review of the extant guidelines, it has been decided to discontinue the practice of issuance of LoUs/ LoCs for Trade Credits for imports into India by AD Category –I banks with immediate effect,” the RBI said in a statement. However, Letters of Credits and Bank Guarantees for trade credits for imports into India may continue to be issued.
Letters of Undertaking (LoUs) and Letters of Comfort (LoCs) are lending instruments through which one bank assures overseas branches of other Indian banks of the liability on customer’s behalf. These instruments were popular for overseas businesses and for imports to India and could potentially impact businesses that are involved in imports to India.
On February 14, PNB revealed to stock exchanges that it has detected a fraud of Rs 11,400 crore at its Mumbai branch committed through the fraudulent issuance of LoUs to benefit a few accounts owned by Nirav Modi and his uncle Mehul Choksi. The bank alleged collusion between the businessmen and a former bank employee. Nirav Modi, using these LoUs raised credit for buyers for which there was no entry in the books of PNB.
The amount of fraud was later raised to Rs 12,700 crore. Both the RBI and the government were sharply criticised for failing to detect the fraud. A multi-agency probe has been launched in the case and several arrests have been made so far. Several Indian banks including largest lender SBI has exposure to the fraud.