LETTERS OF UNDERTAKING (LOU) and LETTERS OF CREDIT (LOC)

Letters of Undertaking (LOU):

• It 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.
  
  
• In other words, it is an assurance given by one bank to another to meet a liability on behalf of a customer.
  
  
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• Letter of Credit:The loan is used to make payment to the customer’s offshore suppliers in foreign currency. I.E. It is issued for overseas import remittances.
  
  

• It is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount.
  
  
• In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.
  
  

View of Parliamentary Standing Committee on Commerce: Summary

• Banning the issuance of LoU/LoC for trade credit by the RBI was done in a hurry without much thought.
  
  
• This has increased the cost of credit by 2% to 2.5% which affects the cost competiveness of the country’s trade and industry.
  
  
• LoUs/LoCs are accepted globally and are an important source of cost-effective short term credit of foreign currency for importers.
  
  
• Thus it is recommended that LoU/LoC should be restored at the earliest with proper safeguards.