PNB fraud case: RBI discontinues system of issuing Letters of Undertaking system

The Reserve Bank of India headquarters in Fort Mumbai

It all started on February 14, when Punjab National Bank (PNB) revealed that it was cheated by two big diamond jewelers namely Nirav Modi and Gitanjali Gem's Mehul Choksi with the connivance of some officials.

Among others, the agency has arrested Gokulnath Shetty, the then deputy manager (now retired) of PNB, in connection with issuance of fraudulent letters of undertaking (LoUs) to Choksi-owned firms.

The CBI has alleged that firms controlled by diamond traders Nirav Modi and his uncle Choksi obtained fraudulent LoUs and letters of credit (LCs) worth United States dollars 2 billion (Rs 12,636 crore) from PNB in connivance with bank officials.

"Letters of credit and bank guarantees for trade credits may continue to be issued subject to compliance with the regulations".

The RBI also banned with immediate effect issuance of letters of comfort which, like LoUs, are used by importers to fund their overseas purchases. "This is clearly a risk mitigating step as letter of credit are governed by Uniform Customs and Practice for Documentary Credits, which has a well defined set of rules and procedures", said a senior official at one of the public sector banks.

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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.

The Bank has reported a Gross Non Performing Assets (Gross NPAs) of Rs 57519.41 Crore (12.11 % of total assets) and Net Non Performing Assets (Net NPAs) of Rs 34075.65 Crore (7.55% of total assets).

The buyer's credit usually goes to an overseas nostro account from where the payment to the importer's bank is made.

Coming back to discontinuance, the central bank's decision is expected to impact businesses who are depended on imports, and needed LoUs for opting bank guarantees.

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