Reserve Bank Bans LoUs and LoCs for Imports

· DGFT Does Likewise for Export LCs!

The Reserve Bank of India on Tuesday asked banks to discontinue issuance of LoU/Letter of Comfort (LoC) for trade credits for imports into India with immediate effect.

An LoU is a document whereby the issuing bank guarantees its customer’s payment obligation to an overseas supplier. A letter of comfort is typically provided by a bank to assure the financial soundness of its customer to repay its debt. Bankers say the scrapping of LoU/LoC is unlikely to impact trade credit as banks can issue Letters of Credit (LC) and Bank Guarantees for trade credits for imports.

An LC ensures that a bank honours the financial obligation of a buyer if he fails to pay the seller. A bank guarantee is a kind of surety given by a bank to a third party on behalf of its customer, assuring the beneficiary that it will effect payment on default of obligation.

A senior banker said, “For import of rough diamonds, big suppliers accept only advance remittance. The issue of LoU for import of pearls in large quantity in the PNB case was rather unusual. Before the PNB episode came to light, I never came across the gem and jewellery trade resorting to LoU/LoC for trade credit.”

Discontinuance of LoU/LoC will have Limited Bearing on Exports : President, FIEO

Reacting to the RBI Notification discontinuing Letter of Undertaking (LoU) and Letter of Comfort (LoC), Mr Ganesh Kumar Gupta, President, FIEO said that the move will have limited impact as such instruments were being used by about 5% of the importers particularly by large industries in Gems & Jewellery, Metal and Petroleum sectors. President, FIEO said that since most of the exporters are using Letter of Credit and Bank Guarantees, which are relatively safe, the move will not have much adverse bearing on exports. However, this may slightly increase the cost as such instruments are costlier by about 0.5% to 1%. He added that none of the instruments are 100% safe and therefore, we should carefully evaluate its pros & cons before discontinuing LoU and LoC as similar kind of instruments are in vogue elsewhere as well.

Mr Gupta said that Banks should not tighten the liquidity to Gems & Jewellery sector as the sector is coming back on track due to good order booking from US, Europe, China, Japan as well as demand within the country. The sector is extremely important as it provides exports to about US$ 43 billion but more importantly gives employment to over 5 million artisans and workers.

[RBI/2017-18/139 - A.P. (DIR Series) Circular No. 20 dated 13 March 2018]

Subject: Discontinuance of Letters of Undertaking (LoUs) and Letters of Comfort (LoCs) for Trade Credits

Attention of Authorised Dealer Category - I (AD Category - I) banks is invited to paragraph 2 of A.P. (DIR Series) Circular No. 24 dated November 1, 2004 and paragraph No. 5.5 of Master Direction No.5 dated January 1, 2016 on ‘External Commercial Borrowings, Trade Credit, Borrowing and Lending in Foreign Currency by Authorised Dealers and Persons other than Authorised Dealers’ (Master Direction), as amended from time to time, on the issuance of LoUs/ LoCs/ guarantees for Trade Credits for imports into India under delegated powers of AD banks.

2. On a review of the extant guidelines, it has been decided to discontinue the practice of issuance of LoUs/ LoCs for Trade Credits for imports into India by AD Category –I banks with immediate effect. Letters of Credit and Bank Guarantees for Trade Credits for imports into India may continue to be issued subject to compliance with the provisions contained in Department of Banking Regulation Master Circular No. DBR. No. Dir. BC.11/13.03.00/2015-16 dated July 1, 2015 on “Guarantees and Co-acceptances”, as amended from time to time.

3. AD Category-I banks may bring the contents of this circular to the notice of their constituents and customers.

4. The aforesaid Master Direction No. 5 dated January 01, 2016 will be updated to reflect the changes. The changes will be applicable from the date of issuance of this circular.

5. The directions contained in this circular have been issued under sections 10(4) and 11(1) of the Foreign Exchange Management Act, 1999 (42 of 1999) and are without prejudice to permissions/ approvals, if any, required under any other law.