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Thursday, Aug 29, 2002

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RBI may permit banks to issue standby LCs

Rukmani Vishwanath

MUMBAI, Aug. 28

THE Reserve Bank of India may allow banks to issue `standby letters of credit' in favour of foreign banks without its prior permission.

Standby letters of credit (SLC) are equivalent to bank guarantees and are widely used in international trade transactions. They originated in the US.

Necessarily a performance guarantee document, SLC can be invoked in the event of default by the party that opens it. It can also act as a guarantee for performance in case of advance payments for goods purchased.

To invoke the SLC, all that the aggrieved party has to do is to write a letter showing the failure of the other party to abide by contractual obligation. SLC is a simpler form of guarantee that can replace the documentary letter of credit.

"In a lot of cases the parties in question may insist on a standby letter of credit instead of a usual bank guarantee or LC. This is an acceptable practice in most countries abroad. In our transactions with them we have to comply with whatever their regulatory requirements are'', said a banker.

The apex bank has sought the views of the Foreign Exchange Dealers Association of India (FEDAI) in this regard, who will study the risks and advantages associated with this move within the legal framework of India and the impact on the exchange control mechanism.

FEDAI is expected to suggest that banks be permitted to use their judgment on a `selective basis' to start with, like for status holders and then gradually make it easily available once the awareness of this product and knowledge of its risks and benefits increase among the users.

The advantage of using SLC is that it does not involve a lot of paperwork and, therefore, will bring down cost of opening several LCs for every transaction and save time.

However, the risks associated are grim for these banks if the letter is invoked. To minimise such threats, banks may be advised to conduct a due diligence on the customer who seeks to open the SLC.

The Uniform Customs and Practice for Documentary Credits 500, (UCPDC 500), to which India has pledged adherence, already has some provisions for standby letters of credit.

At present, it is mostly large public sector enterprises, like oil importing companies and power sector companies, who avail themselves of this facility on a fairly regular basis, in keeping with their import requirements.

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