NiravGate may have claimed its first big casualty. The Reserve Bank of India (RBI) on Tuesday scrapped quasi bank guarantee instruments like Letter of Undertaking and Letter of Comfort in an effort to plug the loopholes in the Indian banking system.
There is no bar on Letter of Credit, which is considered to be amore secure instrument.
The move, which comes as a direct fallout of the Rs 12,600 crore bank loan scam involving Nirav Modi and the Punjab National Bank, is surely bad news for companies, as it would push up their cost of lending.
Banking experts say the decision to scrap LoCs and LoUs will take Indian banking practices one step closer to international standards, even as it increases the responsibility of banks while providing credit lines to traders.
The central bank has been facing a lot of flak ever since the PNB scam rocked the Indian financial market.
Finance minister Arun Jaitley had, in more than one occasion, hinted at the failure of the RBI’s surveillance systems in detecting the mega fraud.
The RBI’s proposal to dump LoCs and LoUs has evoked mixed response from bankers and economists. While some say it is the classic case of closing the stable door after the horse has bolted, some others say the curbs on trade facilitation instruments will make banks riskaverse in credit decisions.
On ET NOW's India Development Debate, the RBI’s decision to scrap LoUs and LoCs was the topic of discussion. Here are some interesting takeaways:
Mythili Bhusnurmath, Consulting Editor, ET NOW
I do think they have reacted unwisely. Why was the damage caused in this particular case? It was outright fraud. The checks and balances at one particular bank branch were flawed. Bank guarantees are still allowed. You can do frauds with bank guarantees as well. Does the RBI ban bills of exchange completely? The anomaly continues. The decision is short-sighted. I hope we don't regret later.
Nitin Khandelwal, All India Gems & Jewellery Trade Federation
The problem is not with our industry. The problem is of banks and their employees. They stopped seeking guarantee enhancements and credit rating. The industry is not prepared to face this kind of a situation. The festival season is coming. Many traders say they are not getting credit from banks. They have to trim jobs. At stake is the fate of around 5 crore people and an industry which is contributing 6-7 per cent of the GDP.
Ananth Narayan, Money market expert
It is not a direct response to the PNB scam. The concept of LoU has an inherent anomaly, and that is what the RBI is trying to address. The client was enjoying credit spread of the local bank. LoUs had become a source of cheap local funds to importers. This is an anomaly which had to be corrected. The immediate impact will be substantial. You could see a bit of a panic in the market.
R Gandhi, Former Deputy Governor, RBI
It is not a knee-jerk reaction. When the regulator finds something is causing damage to the system, it has to contain risks. LoCs and LoUs have created trouble; they have to be stopped. Regulation will come in much later than market practices. Unless it is causing a long-term damage, the regulator won't step in. Normal credit is available; other standard instruments are available. It is not a blow at all.