RBI bars banks from issuing LoUs in Nirav Modi scam fallout

Reserve Bank of India on Tuesday barred banks from issuing guarantees in the form of letters of undertaking as it clamped down on the import financing route used by fugitive jeweller Nirav Modi and his uncle Mehul Choksi for allegedly committing India’s biggest bank fraud.

The Reserve Bank of India also banned with immediate effect issuance of letters of comfort which, like LoUs, are used by importers to fund their overseas purchases.

However, letters of credit and bank guarantees will continue upon meeting certain conditions, the central bank said in a press statement.

Companies belonging to Modi and Choksi allegedly colluded with employees of Punjab National Bank’s Brady House branch in Mumbai to obtain fraudulent LoUs, without providing any margin money as security. They did not have any pre-approved credit limit either.

These firms raised short-term credit from overseas branches of other Indian banks based on these LoUs.

The fraud which began in March 2011, is now estimated to have crossed $2 billion (about Rs 13,000 crore).

“On a review of the extant guidelines, it has been decided to discontinue the practice of issuance of LoUs/ LoCs for trade credits for imports into India” by commercial banks with immediate effect, RBI 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.”

As a trade financing measure, overseas banks usually lend to importers based on the LoUs issued by the importers’ bank. The money thus raised is used to make payment to offshore suppliers in foreign currency.

The change in regulations may hit import dependent businesses and trade that are often reliant on LoUs to get bank guarantees.

Earlier in the day, Finance Minister Arun Jaitley in a written reply to a question in Rajya Sabha said that Nirav Modi obtained his first fraudulent guarantee from Punjab National Bank’s Brady House branch in Mumbai on March 10, 2011 and managed to get 1,212 more such guarantees over the next 74 months.

PNB says junior employees at the branch issued LoUs over the SWIFT interbank messaging system without entering any of these transactions on the bank’s own system. Such transactions went on for six years without detection.

Solar Exports, Stellar Diamonds and Diamond R US belonging to high-end jeweller Modi and Choksi-promoted Gitanjali Gems, Gili India and Nakshatra are alleged to have been involved in the scam.
Central Bureau of Investigation and Enforcement Directorate are leading a multi agency probe into the fraud. Both Modi and Choksi are abroad and have refused to return to face trial.

Ajay Sahai, Director General of exporters’ body Fieo said that the RBI decision should have very little impact on trade as bank guarantee and letter of credit continue to be available.

According to him, LoUs were generally used by large players in gems and jewellery sector.