RBI’s Approach to Solving Bad Loan Issue

Sansar LochanBanking and FinanceLeave a Comment


As per newspaper reports the Reserve Bank of India is likely to take steps towards discontinuing the practice of issuing Letter of Undertakings (LoUs) and Letter of Comforts (LoC). Today we will know what is a LoU and what is an LoC?

What is an LoU?

  1. An LoU is a letter issued by one bank to another assuring the latter to meet a liability on behalf of a customer. Normally such letter has a validity for six months only.
  2. An LoU is issued to enable the customer to make payments for overseas import.
  3. The process of issuing LoUs is guided by the rules framed by SWIFT (Society for Worldwide Interbank Financial Telecommunication).

What is an LoC?

  1. A letter of Comfort is issued by external auditors to an organization or person in reference to the statutory audits, statements and reports presented by the organization/person interested.
  2. An LoC is used as an assurance letter with regard to the comfortable recovery of the loan granted.

Are LoUs and LoC worthy instruments for exports?

Economists believe that for exporters both these instruments serve as means of comfortably raising working capital through banks.

Impact of abolishing LoUs and LoCs

  1. If the RBI abolishes these two old instruments the above board importer will get a huge setback as the credit market is not business friendly at all.
  2. The importer will be forced to raise loan from other sources which might mean higher credit rate.
  3. Exporters may probably shift to the dollar market for capital in which case our dollar reserve may be corroded significantly.
  4. The move to suspend LoUs and LoCs will ultimately hurt the gems and jewellery sector which accounts for 16% of our exports and nearly 50 lakhs employees work in it.

The Way Out

  1. The LoUs and LoCs are old and traditional instruments and need not be abolished just because scams are occurring with their misuse.
  2. The RBI should rather work for enforcing compliance of the rules related to issuing the instruments in question.
  3. The RBI should focus on institutionalizing the whole process in such a way as to ensure complete transparency in the matter of issuing huge amount of loans by banks on the basis of these instruments as well as further codifying the procedure of issuing LoUs by a bank to another.

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