Page 295 - A Banker Down the Rabbit Hole

interest (2 - 5% p. a). He approaches the foreign exchange department
of his bank and asks for issue of a Letter of Undertaking (also known
as Letter of Comfort) in favor of a foreign bank, normally a branch of
an Indian bank overseas who agrees to lend him based on LOU ( a
commitment like a bank guarantee).

In return, the importer's bank would ask him for a collateral in the
form of fixed deposits or other assets up to 100% or even higher than
the credit sought. If his bank is convinced with his dealings, it will issue
an LOU. On getting LOU, the foreign branch of an Indian bank releases
the amount in foreign currency into specific bank account of importer's
bank in a foreign country. It is called Nostro account. Customer then
requests his bank for the payment to be done for his imports. On due
date, he has to repay the loan with interest to the foreign bank.
Occasionally, the loan is rolled over by issue of fresh LOU. This type of
fund raising is known as a Buyer's Credit for imports.

The benefits to the parties involved

The overseas lending bank earns interest on the amount of foreign
currency loan based on LOU. The bank issuing the LOU gets a fat fee.
The borrower gets a much cheaper foreign currency loan at a place
where he may not have banking relationships. Every one gains if loans
are repaid by the importer in time.

Where did it go wrong? How PNB accumulated so much
liability?
An internal investigation revealed that the bank had issued hundreds
of unauthorized LOUs to Nirav Modi and his uncle, Mehul Choksi of
Gitanjali Gems Ltd. The first LOU was issued by two PNB employees
on behalf of the bank via SWIFT, approving loans to be disbursed
abroad.

292 | A Banker down the Rabbit Hole