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Focus on India – how do latest events effect companies trading or operating in the country.

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State-owned lender Punjab National Bank (PNB) has informed the Bombay Stock Exchange that it has detected fraudulent transactions worth $ 1,771.7 million (over Rs 11,000 crore) in its mid-corporate branch at Brady House, South Mumbai. PNB has alleged that two employees had “fraudulently issued Letters of Undertaking (LoUs) and transmitted SWIFT instructions to the overseas branches of Indian Banks” to raise buyers credit for companies of billionaire diamond jeweler Nirav Modi without “making entries in the bank system”.

As the result the Reserve Bank of India has stopped any use of LOUs for the moment.

 

We asked Ingrid Åsheim, senior relationship manager responsible for Indian banks in DNB and Ruby Vazirani, Deputy Representative Officer in DNB Mumbai to describe the situation.

 

What is an LOU? And what is it used for?

Ruby: Letter of Undertaking (LOU) is a provision of bank guarantee, under which a bank allows its customer to raise a foreign currency loan from another Indian / foreign bank's foreign branch in the form of a short term buyers credit. The LOU serves the purpose of a bank guarantee. This was one of the widely used instrument for extended financing of imports as it was cost effective as compared to a deferred payment LC

 

What are the consequences for companies operating in India and trading or producing for foreign clients?

Ruby:  This instrument is used by 5 to 10% of the importers into India for large value/volume import. As an immediate effect importers relying on this instrument will face a cash crunch / higher cost of borrowings as they will need to find cash to pay up for the imports already contracted. In the medium to long term the cost of funding for companies will rise not significantly (by 0.5 o 1%) as they will need to shift to LC’s and other instruments.

 

How does the situation impact DNB and other bank’s credit appetite on Punjab National Bank as well as other Indian banks?

Ingrid: The foreign banks including DNB Bank are watching the space very closely to see that there are no additional surprises that pop out of the PNB closet. There has been no change in appetite on the Indian Banks otherwise. Though it will effect the business in the short term the move is largely positive (risk wise) for foreign banks as the business shifts to ICC approved instruments like LC’s and guarantees.

 

Availing short-term overseas credit could be more difficult. What are the alternatives? 

Ruby:  As mentioned earlier, going forward the importers will shift to other instruments like LC’s which will no doubt increase their cost of financing. Also, in case of LOU financing the importer would arrange for the financing on due date and make payment to the exporter and therefore the exporter was not involved in this type of financing as there was no interaction / agreement required from the exporter. But going forward they will need to explain to the exporter that though the LC is issued with deferred payment terms the exporter will get paid as per contracted terms and get their approval for the same.

 

Can you see the situation being reflected in pricing?

Ingrid: The LOU market was lately dominated by Indian Banks foreign branches which have an advantage over foreign banks financing in foreign currency as Indian banks are not exposed to withholding tax requirements which need to be paid by the importer on interest payable on financing availed from foreign banks. The discontinuance has seen a small jump in the pricing. LC’s being a safer instrument; foreign banks pricing is normally better / lower on LC’s as compared to LOU’s.  

 

Do you have any advice for Nordic companies operating or trading with India?

Ruby: Going forward there will be increased cases of importers approaching the NORDIC exporters for deferred payment terms in the LC’s wherein the exporter continues to get paid as per the contracted terms i.e., sight / 30 days / 90 days / etc. as the case may be but the importer can avail of extended payment terms from DNB Bank for such imports into India. So despite the restriction on usage of LOU/LOC, if the exporters use the deferred LC structure as proposed by DNB they can still offer their Indian counterparties long credit terms as they do today.  It will still be a win win situation for both the importer and exporter. 

 

Ingrid:  DNB has an appetite for Indian bank risk and can arrange for such extended financing for your buyers against LC’s issued by Indian Banks. Exporters will be paid as per contracted terms on WITHOUT RECOURSE basis. DNB will get paid by the Indian  Bank  on due date (after the extended payment tenor) with interest. The risk of non-payment will be with DNB Bank.

 

If you would like to discuss how to finance your operations in India, mitigate risk or finance trade with India, you are welcome to contact us by sending e-mail to: magdalena.stoldal@dnb.no  or contact your Account Officer in the DNB.