RBI LoU ban: Banks, borrowers seek clarity on alternative loan instruments
Following the RBI LoU ban, banks are seeking clarity of alternative instruments are in talks with clients whose letters of undertaking are maturing this week
Mumbai: Confusion reigned as banks and borrowers tried to understand the implications of Reserve Bank of India’s (RBI’s) latest circular that barred the issuance of letters of undertaking (LoUs) and worked on ways to chalk out funding and repayment strategies.
Banks have also sought clarification from RBI on alternative instruments to replace LoUs to fund companies trying to import goods into India, said two bank officials, requesting anonymity.
The banking regulator’s decision to ban LoUs follows the discovery of a $2 billion scam at state-owned Punjab National Bank, which involved jeweller Nirav Modi and his uncle Mehul Choksi, owner of Gitanjali Gems, fraudulently obtaining LoUs from the bank with the help of rogue employees.
To begin with, banks are in talks with borrowers whose LoUs are maturing this week. LoUs are guarantees issued by Indian banks against which a foreign currency loan is availed.
According to Kotak Institutional Equities, India had $86 billion of trade credits, which included LoUs issued in 2017. Of the total, $56 billion was for loans with tenures between six months and one year and $30 billion for less than six months.
A standard LoU is typically rolled over multiple times to help borrowers repay earlier dues. With RBI putting a stop to these instruments, borrowers may have to look to borrow locally to repay the maturing LoUs.
“Banks have the option of sanctioning fund-based rupee credit to importers, so that they can honour the maturing LoUs since they can’t be rolled over. This could be a temporary measure. That apart, borrowers can avail credit through LCs (letters of credit) and BGs (bank guarantees), which are used globally. But over time, borrowers also have the option to move to other sources of foreign funding such as ECBs (external commercial borrowings),” said Ashutosh Khajuria, executive director and chief financial officer, Federal Bank.
In the long term, companies borrowing with the help of LoUs can also look at taking bilateral credit from overseas branches of Indian banks or foreign banks or branches at GIFT city to fund future imports.
Industry bodies are, however, not too happy with RBI’s move as it will impact both trade finance and currency movement.
“Because of the spurt in spot demand for dollars for importers to fulfil their obligation in currency market may go haywire,” said Anil Khaitan, president, PHD Chamber of Commerce and Industry.
“RBI should immediately take measures to enter into bilateral currency swap agreements to meet spot demand and buy back exporters’ receivables. This will enable the smooth currency movement in the market and further it will not impact the forex reserves,” he added.
Analysts said that near-term margins for corporates could decline till they adjust to newer levels of profitability.
Kotak Institutional Equities, for instance, expects system loan growth to be marginally higher than previously expected with higher spreads. However, it also doesn’t rule out a possible risk of higher delinquency for a small segment of customers.
On Wednesday, the Indian rupee opened weaker against the US dollar as importers rushed to buy the greenback over fears that they may not be able to get overseas finance following the central bank’s move to discontinue LoUs.
The Indian currency opened at 64.88 per dollar and touched a low of 65.05 in intra-day trading. However, it recovered and closed higher at 64.84 a dollar, up 0.08% from its previous close.
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