Why in the news ?
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The Parliamentary Standing Committee on Commerce said that the RBI must resume issuance of Letters of Undertaking (LoU) and Letters of Credit (LoC) for trade credit.
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The panel said, the Reserve Bank of India’s decision to discontinue the LoU was a “knee-jerk reaction” to the Punjab National Bank fraud case and the facility should be restored at the earliest.
Background
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The Rs 12,700-crore fraud at Punjab National Bank had prompted the Reserve Bank of India to ban the use of letters (LoUs) and letters of credit (LoCs).
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LoUs and LoCs are two of the instruments issued by Indian banks to domestic
importers to get foreign exchange from banks abroad at a cheaper rate.
Letters of Undertaking (LoUs) :
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An LoU is simply a request made to another bank to loan money to a client.
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LoU is an assurance given by one bank to another to meet a liability on behalf of a customer.
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It is similair to a letter of credit or a guarantee.
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It is used for overseas import remittances and involves four parties ”” an issuing bank, a receiving bank, an importer and a beneficiary entity overseas.
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LoUs are conveyed from bank to bank through “Society for Worldwide Interbank Financial Telecommunication” (SWIFT) instructions.
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The bank that issues the LoU essentially guarantees the bank that receives the LoU request that it stands by the creditworthiness of the borrower. That is, in case of a default, the bank that issued the LoU stands liable to compensate the bank that made the loan to the borrower.
More on news (What panel said)
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The Committee noted that all the stakeholders it consulted, representing trade and industry, unanimously said that the discontinuation of the LoU and LoC facility had resulted in a 2 2.5% increase in the cost of credit.
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It said this will affect the cost competiveness of the country’s trade and industry and have a cascading effect on jobs. The loss of jobs is something the country can ill -afford.
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The Committee said that RBI should have engaged in more consultations with stakeholders on the matter before resorting to discontinuation of LoUs and LoCs.
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The Committee is of the considered opinion that LoU/LoC should be restored at the earliest albeit with proper safeguards.
Source
The Hindu