India's PNB exposure to alleged fraud swells to well above $2 billion

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India's PNB exposure to alleged fraud swells to well above $2 billion

Banks had tightened the rules for issuing LoUs and other guarantees. Indian banks in Hong Kong paid the "suppliers" of these firms based on the LoUs. "An LoU does not have these details and when it is not linked to the banking system it can not be traced like it happened with PNB".

In Nirav Modi's case, LoU is a bank guarantee and was issued for overseas payment. Officials with direct knowledge also said letters of credit have more worldwide acceptability, while letters of undertaking were mostly used between Indian banks.

What happened in this case is that PNB officials allegedly used their access to SWIFT messaging system, which is used for overseas transaction.

RBI said in a notification, "On a review of the extant guidelines, it has been made a decision to discontinue the practice of issuance of LoUs/ LoCs for Trade Credits for imports into India by AD Category -I banks with immediate effect".

It, however, said letters of credit and bank guarantees for trade credits for imports into India may continue to be issued subject to compliance with certain provisions - banks should avoid giving unsecured guarantees in large amounts and for medium and long-term periods, and they should avoid undue concentration of such unsecured guarantee commitments to particular groups of customers or trades.

Ever since the scandal broke out, banks, PNB, regulator and the government have been bickering over how to settle the liabilities arising out of the fraud.

Banks also continue to debate who should assume liabilities from the fraud, with several lenders that have either lent to the jewellery groups based on the fraudulent PNB guarantees, or bought the so-called letters of undertaking from the secondary market, wanting PNB to compensate them.

Until the PNB fraud surfaced, buyers' credit was seen as a safe business because of its short-term nature and the risk of default was essentially on another lender. "LoUs were not recognized as a banking instrument according to the global code and now everything will have to be routed through letters of credit", said a private sector banker.

After weeks of deliberations, PNB has come to a kind of a proposal that could lead to part settlement of the liabilities with a caveat. This is essentially a short-term foreign currency loan on which banks charge say 60 to 90 basis points over the London Interbank Offered Rate or Libor - the global benchmark for pricing loans or lending.

The Economic Times daily, citing unnamed sources, reported earlier on Tuesday that PNB would honour claims by peer banks that issued credit to the jewellers, but with a few caveats. The payment can also be made directly to the importer.

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