Credit tangle

Credit tangle

Context

Aftermath of PNB fraud

What has happened?

In the wake of PNB fraud, RBI has decided to ban instruments like Letters of Undertaking (LoU) as well as letters of comfort issued by bankers to businesses for international transactions. It should be noted that LoUs are among the most popular instruments to secure overseas credit by importers

What will be the impact of this decision?

• Rise of the funding cost for importers: It is estimated that overall, bank finance for imports into India is around $140 billion, of which over 60% is funded through such buyers’ credit. Hence RBI’s recent decision 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.

A better way

As per author, a much better way could have been to tighten the norms for LoUs and introduction of safeguards based on the learnings from PNB incident