K Ram Kumar Balance sheets of Indian bank branches overseas, especially in Hong Kong, may shrink following the Reserve Bank of India’s ban on use of Letter of Undertaking (LoU) as a means of financing imports.

For example, usually an LoU issued by an Indian bank, which has no presence in Hong Kong, would be discounted by other Indian banks in Hong Kong and the amount would be credited to the LoU issuing bank’s Nostro account. The Indian (importer) customer’s Hong Kong-based supplier would get his payment from the LoU issuing bank’s Nostro account.

Now, with the RBI discontinuing the practice of issuance of LoUs/Letter of Comfort for trade credits for imports into India following the ₹12,600-crore LoU scam at Punjab National Bank (PNB), the market for discounting such LoU-based transactions by Hong Kong-based Indian banks no longer exists.

So, once the existing LoUs mature and also in view of the ban on new LoU-based transactions, with effect from March 13, 2018, the asset side of these banks’ balance sheets will shrink.

Fraudulent LoUs issued by one of PNB’s Mumbai branches were discounted by Indian bank branches in Hong Kong and this shook up the entire banking system.

A dozen Indian banks — Allahabad Bank, Axis Bank, Bank of Baroda, Bank of India, Canara Bank, HDFC Bank, ICICI Bank, Indian Overseas Bank, Punjab National Bank, State Bank of India, UCO Bank, and Union Bank of India — operate out of Hong Kong.

Before the RBI ban, Indian banks in Singapore too offered Indian importers short-term finance under LoU issued either by their own branches or branches of other Indian banks.

“Most of the business done by Indian banks in Hong Kong is India related. The RBI move to ban LoUs could push banks to finance more local assets.

“LoUs ranked right up there when it came ‘ease of getting (working capital) loans’ for importers. Now with importers left with only documentary-evidence intensive letter of credit and capital-intensive bank guarantees, costs could go up for them,” said a senior official with a public sector bank.

Bankers say in the backdrop of the PNB scam, Indian banks in Hong Kong may have to pay higher premium on local borrowings in the inter-bank money market in order to support local assets.

In this regard, branches of Hong Kong-based Indian banks will have to weigh the feasibility of borrowing from the local inter-bank market versus tapping their parent for funds.

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