BL :Ramkumar :21 Dec 2013
Due to rising incidents of frauds, banks are not in favour of issuing non-fund based facilities, such as bank guarantees and letters of credit, to non-customers. The Reserve Bank of India had sought feedback on the possibility of allowing sanction of non-fund based facilities by banks to non-customers at a meeting with bankers a few months back.
When it comes to issuing bank guarantees and letters of credit, better the devil you know (existing customer) than the devil you don’t (a new customer who comes for a one-off transaction), said a senior public sector bank official.
A bank guarantee is an instrument issued by a bank in which it agrees to stand guarantee against the non-performance of some action/performance of a party.
A letter of credit (LC) is a written instrument issued by a bank to its customer — a buyer or an importer — whereby it promises to pay the seller (or exporter) for the goods supplied or services rendered, provided the latter presents all documents as stated in the instrument.
Rising defaults
Bankers say in the last few years, instances of bank guarantees getting invoked and LCs getting devolved have increased due to lax monitoring of non-fund based facilities.
For example, in the case of an infrastructure project, if a contractor does not deliver on time, the authorities who commissioned the project can invoke the guarantee issued by the bank in their favour.
Sometimes, contractors use the alibi of projects running behind schedule/cost overruns to get additional finance from banks. The contractors also press home the fact that the bank guarantee could get invoked to get banks to release more funds.
In recent times, LCs issued by domestic banks at the behest of their clients, especially in the gems and jewellery trade, have devolved on the banks, that is, the domestic bank has to pay the exporter’s bank.
The reason for the devolvement of LC usually is that the buyer (or importer) refuses to pay the bank at the end of the credit period even though the imported consignment has been disposed of and profit pocketed.
A senior Union Bank of India official pointed out that if the RBI allows sanction of non-fund based facilities by banks to non-customers it could trigger predatory practices.
Besides, there is also the ever-looming threat of fraud as a customer may approach many banks for getting non-fund based facilities for a single transaction.
In the last few years, instances of bank guarantees getting invoked and letters of credit getting devolved have increased, say bankers
(This article was published in the Business Line print edition dated December 21, 2013)
