The LoUs and Letters of Credits (LoCs) were allegedly misused by diamond merchant Nirav Modi and his uncle Mehul Choksi to defraud state-owned Punjab National Bank of Rs 12,700 crore in connivance of inside bank officials.
The RBI also banned with immediate effect issuance of letters of comfort which, like LoUs, are used by importers to fund their overseas purchases.
The RBI notification further said that Letters of Credit and Bank Guarantees for trade credits for imports into India may continue to be issued subject to compliance with the provisions.
The RBI added that the aforesaid Master Direction will be updated to reflect the changes.
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LoUs and LoCs are two of the instruments issued by Indian banks to domestic importers to get foreign exchange from banks overseas at a cheaper rate. By giving LoU, PNB agrees to repay the principal amount and interest on the clients (Nirav Modi) loan unconditionally.
PNB, the second largest state-run bank, had on February 14 informed the exchanges of detecting Dollars 1.77 billion fraud at its Brady House branch in Horniman Circle area of south Mumbai and named the firms led by Modi and his uncle Mehul Choksi's Gitanjali Group and some other diamond and jewelry merchants as suspects. They did not have any pre-approved credit limit either.
"LoU was an additional route availed by Indian importers". The change in regulations may hit import dependent businesses.
The Finance Minister Arun Jaitley, on Tuesday, in a written reply to the Rajya Sabha revealed that Nirav Modi obtained his first fraudulent guarantee from PNB's Brady House branch in Mumbai on March 10, 2011 and managed to get 1,212 more such guarantees over the next 74 months, reported in PTI.