Letter of undertaking
Also called: LoU · Topic: Banking Regulation, NPAs and Financial Stability · NCERT: Beyond NCERT
Meaning
A Letter of Undertaking (LoU) was a bank guarantee that let a customer raise short-term credit from overseas branches of Indian banks. The issuing bank promised to repay the overseas lender if the customer did not. LoUs were used mainly for import finance. After the PNB fraud, RBI discontinued LoUs in March 2018.
Example
In the PNB-Nirav Modi case (2018), PNB officials issued LoUs through the SWIFT messaging system. They never entered them in the core banking system, so the bank's own records did not show the guarantees. Overseas branches kept lending against them, and PNB was left with huge liabilities. The government then passed the Fugitive Economic Offenders Act 2018.
Don't confuse with
- Letter of credit: here the importer's bank promises to pay the exporter once the specified trade documents are presented. With an LoU, the bank guaranteed repayment to another bank that had lent to its customer.
Related concepts
- Know Your Customer
- Legal Entity Identifier
- Ponzi scheme
- Chit fund
- Subprime lending
- Systemic risk
- Stress test