The $85-billion buyers’ credit market has come to a grinding halt with Indian banks reluctant to provide guarantees through letters of undertaking (LoUs). This has resulted in the interest rates on such instruments going through the roof, making business difficult for small importers.
According to bankers in the trade finance business, the interest rates for buyers’ credit spiked 30 basis points (100 basis points=1 percentage point) after the LoU scam at the Punjab National Bank came to light.
Transaction tenor
According to multiple bankers The Hindu spoke to, interest rates on LoUs were earlier 20-30 basis points (bps) above the London Inter Bank Offered Rate (LIBOR). Following the PNB scam, they have become 50-60 bps above the LIBOR. The tenor of LIBOR is based on the underlying transaction tenor, which is typically three months or six months.
On February 14, the Punjab National Bank, the second-largest lender, informed the exchanges about fraudulent transactions worth $1.8 billion or ₹11,500 crore, in which unauthorised LoUs were issued by one of its branches that helped the fraudsters secure overseas credit. Later, PNB said the amount in fraudulent transactions could go up by another $204.25 million or ₹1,130 crore, taking the total amount involved in the scam to $2 billion.
The interest rate on buyers’ credit is the lowest among all credit products in India. “This is a rate that no other credit product offers. If you take a rupee loan, it comes to around 9-10%, but buyers’ credit interest rate is around 2.5%,” said a senior executive from a private sector bank.
When an importer approaches a domestic branch of bank, say AB Bank, seeking overseas credit, the branch issues a letter to another Indian bank located in overseas territory, say YZ Bank, for buyers’ credit with a guarantee to repay YZ bank on the due date. Then, the overseas branch of YZ Bank transfers the fund in the NOSTRO account of AB Bank.
The increase in the interest rate for buyers’ credit is making it difficult for small traders who import goods now will not have the bargaining power to pass on the increase of higher cost to customers.
“The importer typically enters into a forward contract with the buyer promising them to supply at a particular rate. However, now the cost of the import has gone up... after buyers’ credit interest rate increase but the person will not be able to pass on the hike to the customer,” said a senior official from a large foreign bank.
The scam in PNB has also made the foreign lenders cautious in their dealings with to involve in trade finance business with Indian banks for trade finance. According to bankers, not many foreign banks are showing interest in funding buyers’ based on letters issued by Indian banks.
This is because PNB has been reluctant to honour its commitment to other Indian banks which had released funds overeseas on the basis of to , those discounted PNB’s LoUs issued to the Nirav Modi group of companies - the prime accused in the case.
