RBI ban on LoUs; PSU bank stocks recover after early setback

Last Updated: Wed, Mar 14, 2018 13:29 hrs

Mumbai: Well, it appeared at the start of today's session that the recovery in the banking space witnessed on Tuesday on reports that Bank of India recovered bad loans worth about Rs 7000 crore in the past couple of months and that Punjab National Bank would compensate lenders who suffered due to the alleged fraud in the bank, would fizzle out following the Reserve Bank of India banning credit gurantees.

PSU bank stocks, big and small, declined early on in the session today as the central bank has barred the institutions from issuing letters of undertaking.

But most of these stocks recovered swiftly, and many stocks have emerged into positive territory now.

Sector heavyweight State Bank of India is down just marginally, after having lost more than 1% early on. Punjab National Bank, which was down by about 4% in early trades, is down just about 1% now.

Bank of India is trading 0.75% up. Union Bank of India is gaining 3.2% and Indian Bank is up 3%. Syndicate Bank, Bank of Baroda, IDBI Bank and Oriental Bank of Commerce are up 2.3% - 2.5%. Allahabad Bank, Canara Bank and Andhra Bank are also notably higher.

However, the private sector banking space is somewhat subdued. Federal Bank, ICICI Bank, Kotak Bank, Axis Bank, IndusInd Bank, HDFC Bank and South Indian Bank are weak. IDFC Bank is up 0.5% and RBL Bank is gaining 1.2%, while Yes Bank is up with a gain of 2.3%.

The apex bank's move is likely to hurt banks' revenues as their trade credit business will suffer. But then, looking at the positive side, the move will significantly help curb irregularities and fraud in the banking sector.

A Letter of Understanding (LoU) allows the bank's customer to raise money from another Indian bank's foreign branch in the form of short-term credit. With the central bank banning the banks from issuing LoUs, importers who rely on this instrument to raise money abroad to pay their import bills are likely to suffer heavily.

The central bank has decided to ban issue of credit guarantees like Letter of Undertaking and Letter of Credit following the unearthing of the scam involving diamond merchants Nirav Modi and Mehul Choksi, who had misused LoUs issued by Punjab National Bank, the second largest PSU bank in the country, to defraud it by nearly Rs 13,000 crore.

The decision to ban LoUs and LoCs is likely to hurt trade financing activities in the country and result in increased costs for importers engaged in businesses such as gems and jewellery, oil and gas, electronic goods, solar panels and metals.

Still, with oil & gas, electronic goods and metals sectors mostly rely on bank gurantees rather than LoUs and LoCs and hence, it is felt in some circles that the impact of RBI's move may not hurt these sectors long term.

There could be serious problems for those companies which have mopped up funds based on LoUs as they cannot now rollover their LoUs due to the ban.

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