Nirav Modi Effect: RBI Stops Letters of Undertaking For Overseas Credit

A man leaves an automated teller machine facility of Punjab National Bank in New Delhi

Banks can continue to issue guarantees and letter of credit for trade purposes which are the global norm, and also have features that makes the claim on the issuer strong.

It, however, said letters of credit and bank guarantees for trade credits for imports into India may continue to be issued subject to compliance with certain provisions - banks should avoid giving unsecured guarantees in large amounts and for medium and long-term periods, and they should avoid undue concentration of such unsecured guarantee commitments to particular groups of customers or trades.

He said as per inputs from PNB, messages were sent via SWIFT to overseas branches of Indian banks, regarding fraudulently issued LoUs/FLCs without entering the transactions in the bank's Core Banking System (CBS).

"On a review of the extant guidelines, it has been chose to discontinue the practice of issuance of LoUs/LoCs for trade credits for imports into India by authorised dealer (AD) Category-I banks with immediate effect", the central bank said in a notification.

The Enforcement Directorate and the Central Bureau of Investigation (CBI) are already investigating the case, and have seized several assets related to both Nirav Modi and Mehul Choksi's companies. According to a court filing seen by Reuters, the police also told the court that Mehul Choksi's companies controlled by billionaire Nirav Modi defrauded the lender of Rs 708 crore. The RBI had said it confidentially cautioned and alerted banks of such possible misuse, at least on three occasions since August 2016, advising them to implement safeguards and about the potential malicious use of the SWIFT infrastructure. Importers, especially in the gem and jewellery sector, will have a tough time to finance their import business.

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Currently, importers can avail of short-term buyers' credit of up to a year at 8% annualized on a full-hedged basis, said Sajal Gupta, head, forex and rates, at Edelweiss Securities Ltd.

The move is likely to lead to a freeze in trade financing activities in India, increasing costs for importers who have relied on these instruments to get cheaper overseas credit to pay suppliers.

Charges on such credit had already started rising as banks became more cautious following the PNB fraud.

Bankers said letters of credit involved more paperwork and the due diligence was more stringent than letters of undertaking. There was no credit limit either. It will also put companies that have received credit based on LoUs in a spot, as they have to now repay their borrowings since there will no rollover of existing LoUs.

PNB said the additional amount did not involve any fraudulent letters of undertaking, but was sanctioned credit to Gitanjali group that it was recalling and adding to the total amount defrauded.



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