RBI ban on LoUs: Lenders tighten process, import costs may go up

“Each bank has already scanned their LoU/LoC related transactions and have confirmed during the workshop that all of them are properly assessed, genuine and accounted for except those already reported. Further controls have also now been put in place that includes additional layer of approval for all outward swift messages, integration of SWIFT with CBS latest by April 30, 2018 besides time restrictions for such transactions i.e. between 9 am to 8 pm only,” said an official. Executive directors, chief risk officers and chief technical officers of PSU banks met in Gurgaon on Thursday to ascertain the prevailing risk management practices and arrive at a common understanding on best practices.

Read | Nirav Modi fallout: RBI discontinues LoUs, may impact trade financing

Bankers said they have tightened the rules for import credit — even for LCs and bank guarantees — after the surfacing of the Punjab National Bank scam. “We are asking for more papers and collateral. The cost of funds which is based on Libor will also rise. LoUs were used by companies across sectors. Now, existing LoUs will have to be cut down which may prove another headache for bankers,” said a banking source.

Overseas branches of Indian banks will have to bring down their exposure, estimated at over Rs 50,000-60,000 crore, to zero as per the RBI directive. While PNB’s exposure in LoU alone was close to Rs 13,000 crore, data from other banks is not available.

Meanwhile, many importers warned of a rise in import finance costs to 3 per cent — 100 bps above Libor. “The sudden withdrawal of LoUs or LoCs by Indian banks as per RBI circular is highly detrimental to imports. There will be sudden funds crisis and companies who avail bank credit for “at sight” import documents will face the music. Companies which also have higher trade cycle will face issues regarding funding of transactions .The cost of funds are going to go up substantially. This seems knee jerk reaction to the Nirav Modi fraud but it will have highly negative impact on trade and industry,” said Nikunj Turakhia, President of Steel Users Federation of India (SUFI).

Read | Ban on LoUs to have disruptive impact: India Inc

LoU is a provision of bank guarantee, under which a bank allows its customer to raise money from another Indian bank’s foreign branch in the form of a short term credit. However, to be able to raise the LoU, the customer is supposed to pay margin money to the bank issuing the LoU and he is granted a credit limit. Companies and importers will have to switch over to Letter of Credit (LC) which is commitment by a bank on behalf of a buyer that payment be made to a seller provided that the terms and conditions stated therein have been met. In a LC-based transaction, the goods are consigned to the order of the issuing bank, meaning that the bank will not release control until the buyer has either paid or undertaken to pay the bank for their guarantee. “The decision of RBI to discontinue LoU and LoC for trade credit would have a disruptive impact on the buyers’ credit market, in the immediate term. Traders who have been conducting business through these two instruments will now have to necessarily shift their transactions to LC and Bank Guarantees. The result would be that cost of credit may go up, especially for the SMEs,” said Shobana Kamineni, President, CII.

Sabyasachi Ray, Executive Director, Gem and Jewellery Export Promotion Council (GJEPC), said companies which were using LoUs will now shift to bank guarantees (BGs) and LCs. “However, the issuance of bank guarantees will take more time. Instead of one or two days in the case of LoUs, bank guarantees are likely to take three of four days. There will be strict scrutiny of the application and banks will have to ensure there’s enough collateral,” Ray said.

All bank guarantees, letters of credit (LCs) and letter of undertaking (LoUs) fall under the off balance sheet business. Total guarantees given by the banks amounted to a whopping Rs 10.83 lakh crore as of March 2017, constituting 7.7 per cent of the liabilities of the bank group. Credit extended by all categories of banks declined during 2016-17. Lending formed nearly 60 per cent of total assets of overseas branches of Indian banks ($ 224 billion) in March 2017. Fee income of Indian banks operating abroad from trade finance related services rose from Rs 1370 crore to Rs 2020 crore in 2016-17, according to RBI data.