Bulk gold, diamond importers to take biggest hit as RBI bans LoUs and LoCs for trade credit after PNB scam

The Reserve Bank of India (RBI), which according to the former governor Raghuram Rajan had no clue about the Punjab National Bank scam, on Tuesday barred the lenders from issuing letters of undertaking (LoU) and letters of comfort for trade credits. Rajan had expressed in a TV interview that the central bank would have prevented the scam had it known about it.

With the RBI's move, majority of the sectors which rely on imports and exports will not get affected in a big way, except for an identified few. According to this The Economic Times report, bulk importers of gold and diamond may find themselves at the receiving end of the RBI’s move. The report adds that at present most of the trade finance is completed through bank guarantees and letters of credit.

Representational image. Reuters.

The RBI while backing its ban in a statement said, “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 comfort and bank guarantees for trade credits for imports into India may continue to be issued subject to compliance with the certain guidelines on guarantees and co-acceptances, the RBI added.

According to The Economic Times report which quotes industry expert who said letters of undertaking account for only 4 to 5 percent of total trade finance which is not a substantial chunk.

It must be noted that most of the trade in the gems and jewellery industry happens on bank guarantee and letter of credit, which is the fundamental reason why the sector will face the heat after the ban on LoUs and LoCs.

The Rs 13,600 crore scam was exposed on 14 February when the PNB informed the stock exchanges that its Brady House branch in South Mumbai has reported a fraudulent transaction worth over Rs 11,000 crore. The later part of the investigation unearthed an additional Rs 1,300 crore scam in which diamantaire Nirav Modi and his uncle Mehul Choksi of GItanjali Gems are prime accused.

The uncle-nephew duo had allegedly roped in senior PNB officials at the Brady House branch, where the scam has occurred, to get unauthorised and unmonitored LoUs to commit the Rs 13,600 crore fraud which has been touted as largest scam in India’s banking history.