Letters of undertaking (LoUs)

Why in news?

Rattled by a spate of banking frauds, RBI has initiated special audit of State-owned lenders with focus on trade financing activities, especially relating to issuance of letters of undertaking (LoUs) by them.

FACTS FOR PRELIMS

LoU

Technically, Letter of Undertaking is a bank guarantee under which a bank allows its customer to raise money from another Indian bank’s foreign branch in the form of short-term credit.

The loan is used to make payment to the customer’s offshore suppliers in foreign currency. The overseas bank usually lends to the importer based on the LoU issued by the importer’s bank.

Importance of LoU

LoUs are important instruments that allow those in the import trade to transact their business.

As an importer in India cannot simply buy dollars and send it abroad to make payments to his supplier, various instruments such as LoUs and Letters of Credit are required to carry out the transaction. LoUs, which are essentially a form of guarantee, have come to be a far cheaper and convenient way for importer to raise credit.

SOURCE – THE HINDU.