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Ban on LoU credits

Kashmir Times. Dated: 3/19/2018 10:10:29 AM

The RBI's ban on a legitimate financing instrument is not the solution and will hit business of both imports and exports

The Reserve Bank of India's (RBI) decision to put a blanket ban on Letter of Undertaking (LoU) as well as Letters of Comfort issued by the bankers to businesses for international transactions may hit both the business of imports and exports from India. The decision coming a month after the Rs 12,800-crore LoUs fraud at Punjab National Bank was detected appears to have guided by haste on the part of RBI. While the NDA-government has been in fire-fighting mode, unleashing all investigative agencies to probe the fraud, this is the first major step by the central bank on the issue, apart from asking banks to ensure that there are no slip-ups between their core banking systems and the SWIFT mechanism used for international money transfers. LoUs are among the most popular instruments to secure overseas credit by importers - known as buyers' credit in banking parlance - because of their attractive pricing. It is estimated that overall, banks' finance for imports into India is around US Dollar 140 billion, of which over 60 percent is funded through such buyers' credit. It is but natural that industry is unhappy with the RBI decision as this would raise the cost for importers, who will now need to rely on more expensive instruments such as bank guarantees and Letters of Credit. The move will also impact the competitiveness of exporters who import raw materials for their products, sold in the domestic markets and for exports to other countries. This step is also likely to have severe impact on the working of industrial units because the imports of raw material and imports of some of the goods from other countries will be delayed by an uncertain period. The industrial sector and the manufacturers will take a long time to secure credits for their operations from the banks when they will go in for costly bank guarantees for this purpose. Moreover, the RBI has not provided an alternative route for the business houses which are dependent on finance from the banking institutions. The business is also likely to witness a downturn and slowdown when the corporate houses will look for alternate finance options from the foreign banks.
The central bank, which is supposed to act as a regulator, had previously blamed 'delinquent behaviour by one or more employees of the bank' and failure of internal controls for the PNB-Nirav Modi fiasco, RBI Governor Urjit Patel has finally commented on the fraud. Urjit Patel said he had chosen to speak because the central bank also feels the anger and pain over the banking sector frauds that amount to 'open looting' the country's future by 'some in the business community, in cahoots with some lenders'. Reiterating that PNB's internal systems failed to take note of the RBI's warnings about such risks, Urjit Patel took on severe criticism about the RBI's inability to detect the fraud. The RBI chief stressed that the central bank didn't have adequate powers to regulate public sector banks, and it could not remove any of their directors or liquidate such a lender, as it can in the case of private sector banks. He made an eloquent demand that the owner of public sector banks i.e. the government, must consider making the RBI's powers over banks 'ownership-neutral' and say what could be done with these banks. The RBI's stance is valid, as is its discomfort with knee-jerk reactions and the blame games since the fraud came to light. In the very same vein, its omnibus ban of LoUs will impact the US Dollar 85 billion buyers' credit market that was mostly conducted in accordance with the law of the land. If an individual or some failed systems of a bank were to be blamed, why should genuine transactions suffer? Perhaps the RBI could have tightened the norms for LoUs and introduced safeguards based on the latest learnings. It is still not too late to do that in view of the fact future transactions and attempts to commit frauds can be checked. In the process, the RBI has failed to take into consideration the political interference in the working of the banks and extension of credits to some favoured corporate houses, which are solely dependent on 'crony capitalism'. Some of the cases that have taken place in the recent years particularly under the NDA-regime for extension of huge credits should be brought under scrutiny. Some of these huge credits could not have happened without the intervention of the politicians in power without adequate safeguards. The RBI should put in place mechanism to prevent such frauds which have been committed under political patronage. This is because of the fact that Nirav Modi fraud could not have been committed without the involvement of the politicians from the ruling elite.