MUMBAI: Overseas branches of Indian banks will have to rejig their business model after the Reserve Bank of India (RBI) decided to ban letters of undertaking (LoUs) as a trade finance instrument, since most of their assets abroad are linked through this instrument.
LoUs were liberally issued, especially by PSU banks instead of letters of credit (LCs), because it helped them earn fees for just issuing a guarantee. This wasn’t an international banking practice but used by Indian bank branches abroad. But as these instruments are wound down in the next three months, these banks will also have to reduce their liabilities to balance their books.
“PSU banks which are already in the ICU will be hit further by this ban. Half the asset side of their business in their overseas branches is in LoUs and these will have to be wound down in the next three months, which means that they will also have to pay back liabilities to match their balance sheet. This will not be easy,” said a senior banker from the SBI group, the country’s largest lender.
Depleted assets would mean banks will have to balance their books by finding new assets to invest in or reduce their liabilities where they can. Liabilities of banks include deposits from customers, inter bank borrowings and also market borrowings such as dollar bonds issued from their branches abroad which cannot be recalled easily.
Public sector banks have already discontinued issuing these instruments in the wake of the Rs 13,000-crore PNB scam. The central bank’s notification on Tuesday wants to make sure that such a problem doesn’t crop up again.
“These LoUs will have to be wound down in the next few months and judging by the fact that PNBBSE -0.10 % itself had $2 billion in these instruments, the total outstanding liability of the banking system could be $10 billion, which will be wound down in the next few months,” said a senior private sector banker.
Trade financing moving to only LCs will also increase the cost for importers as these instruments involve a commission fee along with a so called acceptance charge which is not the case with LoUs as they only involve a guarantee fee.
“It will definitely increase costs for importers. Only genuine LCs-backed transactions will enjoy trade credits, but at a bit higher pricing than LOUs. Old, time-tested international trade products such as letter of credit financing, sight letter of credit post financing, suppliers’ credit, etc., will make a comeback in this market,” said Joiel Akilan, chief India representative for BBVA, Spain’s second largest lender.
Some trade finance business could move to private sector banks, said Suresh Ganapathy, analyst at Macquarie India. “(However), it will be too naive to conclude that this will have a permanent structural impact in the longer term,” he said.
Public sector banks say they are ready for the transition to LCs. “Fee wise, it was not such a big part of our revenues, so it will have little impact on our business. Most of this financing will move to LCs in a few months,” said Rajkiran Rai, CEO at Union Bank of IndiaBSE -0.88 %.
Source : economictimes.indiatimes.com