Scrapping of LoUs by RBI will raise cost of credit: CII

New Delhi, March 14 (IANS) Reacting to RBI's decision to scrap the system of issuing Letters of Undertaking (LoUs) and Letters of Comfort (LoC) by banks in the wake of the Rs 12,600 crore fraud on state-run Punjab National Bank (PNB), industry body CII said on Wednesday it would have a disruptive impact on the buyers credit market,

The Reserve Bank of India (RBI) on Tuesday discontinued the system of issuing LoUs and LoCs by banks for availing trade credits for imports into India following last month's unveiling of the PNB fraud by accused diamantaire Nirav Modi and his uncle Mehul Choksi.

"The decision of RBI to discontinue Letters of Understanding and Letters of Comfort for trade credit would have a disruptive impact on the buyers' credit market, in the immediate term," CII President Shobana Kamineni said in a statement here.

"The traders who have been conducting business through these two instruments will now have to necessarily shift their transactions to Letters of Credit and Bank Guarantees. The result would be that cost of credit may go up, especially for the SMEs."

CII feels that RBI could have strengthened and tightened the existing regulations on LoUs and LoCs, or could have announced a phasing out mechanism, rather than completely discontinuing a legitimate and established product.

As per the RBI's latest notification, Letters of Credit and bank guarantees for trade credits can continue to be issued.

LoUs are bank guarantees through which a bank allows customers to raise money from another Indian bank's foreign branch as short-term credit.

The PNB scam involved using LoUs issued in favour of the accused by bank employees who misused their access to PNB's SWIFT -- the electronic messaging system employed for overseas funds transfers.