Parliamentary panel on Commerce advocates restoring LoUs with proper safeguards to improve credit for traders; Will RBI relent?

Last Updated: Tue, Aug 07, 2018 18:38 hrs
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New Delhi: If the Parliamentary Panel on Commerce has it's observations correct, the Reserve Bank of India could soon be prompted to revoke it's ban on Letter of Undertakings.

The central bank had banned banks from issuing letters of undertaking ever since the sensational Nirav Modi-PNB case got exposed.

But, in a recent report, the Parliamentary Panel on Commerce made some scathing observations. The Central Bank will be prompted to act on the lines suggested by the parliamentary panel.

The Parliamentary panel expects the RBI, to re-introduce LoUs, a trade finance instrument with proper safeguards in order to increase the availability of credit for traders.

"It is of the considered opinion that LoU/LoC should be restored at the earliest albeit with proper safeguards. Its restoration assumes more significance in the face of the fact that the content of imports is over 20% of India's total exports," it said in its report - Impact of banking Misappropriation on Trade and Industry.

In the report released on Tuesday, the Committee on Commerce said that the ban of LoU/LoC had resulted in rise in the cost of credit by 2 to 2.5%. The committee said that in present times when the currency is witnessing high depreciation, it was imperative that the cost of credit for imports must be minimal.

"The ban on LoU/LoC takes away the benefit of a cheap source of funds availed by the importers. Costly imports shall lead to higher costs of production and erode the competitiveness of the domestically produced goods," it conceded.

It also stated that discontinuation of LoU/LoC as a response to the fraud and misappropriation has set in a contagion of conservatism in the banking sector.

"The caution has inadvertently made banks becoming inaccessible to MSME sector....such an approach has the dangers of making banking services elitist and subservient to a few large corporates leaving out the vast majority of MSME units which are not able to measure to the standards and parameters laid down by external credit rating agencies for getting AAA or AA ratings," it added in the report.

The move to ban LoUs, the committee observed, would certainly affect the cost competitiveness of country's trade and industry and have a cascading effect on jobs and the loss of jobs is something the country cannot ill-afford.

The committee also observed that the central bank should have engaged more in consultations with stakeholders on the matter before resorting to discontinuation of LoU/LoC.

In March, Reserve Bank of India banned issuance of Letters of Undertaking (LoUs) and Letters of Comfort (LoC), used extensively for trade finance, following the unearthing of fraud at Punjab National Bank (PNB) that was carried out allegedly by diamond jeweller Nirav Modi and his associates.

The central bank banned LoUs in the aftermath of Punjab National Bank's sensational claim of Rs 14,000 crore scam, allegedly masterminded by Nirav Modi. The scam brought to the fore major loopholes in the banking system, majorly linked to a connectivity between SWIFT -Core Banking systems and also LoUs.

The RBI's action will depend upon a number of factors. Although the central banker gets minute details from banks, not all banks are expected to report on trade finance related aspects. Especially those linked to LoUs. If tackling the growing cases of Non Performing Assets and the credit culture in the country via adjusting repo-rates, the central bank is also tasked with studying varioous sectors and suggesting credit to those.

Should the RBI relent?