In the backdrop of Punjab National Bank (PNB) scam that is being blamed on two jewellers Nirav Modi and Mehul Choksi, the Reserve Bank of India (RBI) on Tuesday, chose to discontinue the Letter of Undertaking (LOU)/ Letter of Credit (LOCs) for trade credits for imports with immediate effect.
The apex bank in its notification said,"It has been chose to discontinue the practice of issuance of LoUs/ LoCs for Trade Credits for imports into India by AD Category -I banks with immediate effect".
The RBI also barred the issuance of letters of comfort, but said letters of credit and bank guarantees can be continued to be issued if certain rules are met.
The RBI's action comes almost a month after PNB announced that it had detected fraudulent and unauthorised transactions at its Brady House branch in Mumbai.
Companies belonging to Modi and Choksi allegedly colluded with employees of Punjab National Bank's Brady House branch in Mumbai to obtain fraudulent LoUs, without providing any margin money as security. Moreover, the buyer's credit raised was not used for specific purposes in many cases.
The sector also got a boost on news that Bank of India recovered about 70 billion rupees ($1.08 billion) that had earlier been categorized as bad loans. It is used (by the importer) to pay for the imports into the country. "In the case of LCs for import of goods, banks should be very vigilant while making payment to the overseas suppliers on the basis of shipping documents".
The issuance of LoUs as a guarantee for credit, has come under fire since the instrument was grossly misused in perpetuating the biggest bank fraud in recent history. A nostro account is an account held by an Indian lender in a foreign bank in their currency.
After the unearthing of the PNB fraud, an RBI notification last month said: "The risks arising from the potential malicious use of the SWIFT infrastructure has always been a component of their operational risk profile".