RBI’s hasty move

The Reserve Bank’s move to ban the issue of letters of undertaking (LoU) — the instrument used by jewellers Mehul Choksi and Nirav Modi to decamp with a staggering ₹13,000 crore or more in foreign currency — is perhaps an overreaction. In the case of the Modi-Choksi duo, a Mumbai branch of Punjab National Bank issued them LoUs — an undertaking by PNB to pay up for them in case they did not repay a short-term foreign currency loan taken at an overseas branch — for years on end, without at all being clear on whether they had repaid their earlier loans. With the RBI’s Tuesday diktat, importers can only obtain credit through a ‘letter of credit’, a traditional instrument that, unlike LoUs, requires them to furnish details of their transactions. Thanks to the free use of LoUs, it is not clear how Modi-Choksi used the money borrowed over time. That said, the RBI seems to have overlooked the fact that LoUs serve a useful business purpose – while an LC can be opened only after a transaction is settled, an LoU, by releasing credit upfront, allows bonafide importers the breathing space to take a considered commercial decision. Given the reduced cost of overseas credit, it has emerged as a favoured instrument of trade finance. Not surprisingly, the RBI’s step has raised an uproar from exporters and the business community. Whether the transition causes turbulence in the currency market, as some fear, remains to be seen.

However, the key issue is to get to the bottom of the PNB scam. PNB has rightly raised questions on how the overseas banks concerned — State Bank of India, Canara Bank, Allahabad Bank and Axis Bank — kept issuing credit against rolled-over LoUs without bothering to check what was going on. Whether they were just lax or complicit is not clear. That they never actively pressed their claims against PNB also points to a modus operandi of routing money that calls for an explanation. Besides the systems failure at a branch office in PNB, where the core banking and SWIFT mechanisms were utterly compromised, there have been grave lapses at the overseas end. It appears in hindsight that the RBI and the banking apparatus have been too preoccupied with extraordinary functions, such as dealing with demonetisation, opening Jan Dhan accounts and pushing insurance products, to perform their routine tasks with due rigour.

It is also worth probing whether LoUs have become an instrument to ‘round-trip’ black money. The gems and jewellery trade, a prominent voice in the chorus of protest against the RBI’s move, is particularly suited to this sort of activity, as valuations can be manipulated. That said, a considered step to regulate LoUs, that does not throw out the baby with the bathwater is advisable.

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