Don’t miss the latest developments in business and finance.

What is the 'Letter of Comfort' banned by the Reserve Bank of India?

The ban imposed by the RBI may impact loans worth Rs 35,000 crore, impacting power, healthcare, engineering & construction, and road sectors the most

Bs_logoRBI
Photo: Bloomberg
BS Web Team New Delhi
2 min read Last Updated : Aug 11 2022 | 5:17 PM IST
The Reserve Bank of India (RBI) has disallowed the use of Letters of Comfort (LoC), which may impact loans worth Rs 35,000 crore. Sixty per cent of these belong to power, healthcare, engineering & construction, and road sectors, a Times of India report stated.

What is a Letter of Comfort (LoC)?

LoC is a letter issued by a parent company which tells a bank that they know the loan is availed by one of their subsidiaries. The letter states that the parent company "supports" the subsidiary in the process, and they will lend their hand wherever required.

It is generally issued by foreign companies that have their branches and subsidiaries in India.

The official format of LoC released by the RBI says, "Any liability that may arise due to the functioning of the Branch/Liaison Office in India will be met by us (the parent company), in case of inability on part of the Branch/Liaison Office to do so."

However, it must be noted that the company is not legally liable to cover for the defaults by its subsidiary, even if they had issued an LoC. It is issued merely to assure the lending bank that the parent company is aware of the credit being sought.

The RBI, on July 26, asked the credit rating agencies in their Frequently Asked Questions (FAQs) to ignore these letters while assigning the ratings, the TOI report added.

According to RBI's guidelines, the official LoC must also enclose the parent company's financial details. The declaration reads, "We are also enclosing the financial background of our company in the form of our latest Audited Balance Sheet / Account Statement certified by a Certified Public Accountant."

From March 31, the Finance Ministry has also restricted the ministries and departments from issuing an LoC on behalf of the hired entities. The entities use the LoC to acquire funds to complete the projects assigned to them.

"Henceforth, no 'Letter of Comfort' will be issued by any entity within the government," the FinMin notification said. The government stated that it was done to improve financial transparency in the banking system.

With the RBI's announcement, the credit rating of around 100 entities is expected to go down. TOI also stated that the RBI may also disallow public sector undertakings to use LoC to get more loans.

However, it may not have an immediate impact on the borrowers.

Topics :Reserve Bank of IndiaRBIBankingloanshealthcarePetron Engineering ConstructionRoad sectorFinance MinistryRBI PolicyReserve BankRoad companies

Next Story