Ban on LoUs/LCs: House panel says RBI acted in haste

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New Delhi | Published: August 7, 2018 1:01:33 AM

A parliamentary panel has said the Reserve Bank of India (RBI)'s ban on letters of undertaking/comfort in the wake of the $2.2-billion fraud at Punjab National Bank was a “knee-jerk” reaction and suggested that such credit instruments be restored.

According to the report, export credit dropped 24.4% in the last fiscal and as a percentage of priority sector lending, it was only 1.74%.

A parliamentary panel has said the Reserve Bank of India (RBI)’s ban on letters of undertaking/comfort in the wake of the $2.2-billion fraud at Punjab National Bank was a “knee-jerk” reaction and suggested that such credit instruments be restored.

Some PNB staff at a Mumbai branch issued illegal LoUs/LoCs to jewellers Nirav Modi and Mehul Choksi, causing the biggest fraud in the Indian banking history, which prompted the RBI to stop these instruments that were widely used in trade finance.

“It’s (banning LoUs/LCs) a typical case of throwing baby along with bath water and it must be stopped,” said a report by the Parliamentary Standing Committee on Commerce, headed by Rajya Sabha member Naresh Gujral.

It, however, recommended that adequate safeguards be built in the system to ensure LoUs/LCs can’t be abused. The report, presented in Parliament on Tuesday, also called for necessary steps to simplify and streamline the processing of letters of credit (another such instrument that wasn’t banned).

According to the report, export credit dropped 24.4% in the last fiscal and as a percentage of priority sector lending, it was only 1.74%. “The committee felt that such a decline in exports credit, along with discontinuance of the issuance of the LoU/LC, might not augur well for the future. In case of Nirav Modi and Choksi, these guarantees, issued fraudulently, were used by them to borrow overseas to fund imports.

The report said: “The committee is not satisfied with the justification proffered by the RBI for discontinuing issuance of LoUs/LCs” and that the central bank has perhaps not held enough consultations before banning these instruments.

According to the committee, the RBI said it was advised by Foreign Exchange Dealers Association of India (FEDAI) to discontinue these instruments as “there was neither a standard format for LoUs/LCs nor a standard protocol, like the one prescribed by the ICC (International Chambers of Commerce) in respect of LCs (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 endorsed the fact that they were not flawed, the report said. “Instead, these were means of raising cheaper finance for trade.”

The Department of Financial Services (DFS) had sought comments from the central bank on the impact of scrapping LoUs/LCs on credit costs of short-term foreign currency loans. The central bank, according to the panel, said there was no comparative reporting on the quantum or cost of trade finance through LoUs/LCs against other available avenues. Apart from traders and exporters, the DFS had in March urged the central bank to review the restriction.

Earlier, Federation of Indian Export Organisations president Ganesh Kumar Gupta had said the ban could raise the cost of trade financing instruments by about 0.5% to 1%. According to a report by India Ratings, total buyer credit for the top 160 importers was Rs 33,100 crore in 2016-17, of which Rs 31,200 crore was to large importers.

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