What is a letter of comfort?

In April this year, the Union finance ministry had barred ministries and departments from issuing letter of comfort. The idea was to usher in transparency. And now, the Reserve Bank of India has disallowed such quasi bank guarantee instrument provided by a corporate. So what is this document?

A letter of comfort is a support document issued to a borrower that adds some strength to the transaction when giving loans. Letter of comforts are usually issued by a third party or a stakeholder in the transaction. For instance, a holding company can give a letter of comfort on behalf of its subsidiary or a government can issue a letter of comfort for public sector enterprises. The letter of comfort can also be issued by banks, NBFCs and auditors.

The letter of comfort is not legally binding or an obligation by the holding company to repay the loans. It is just an assurance to the lender that the holding company is aware of the transaction, the policies of the subsidiary and its intentions in seeking a loan. This provides some comfort to the financial institution to lend money for short term or long term. One can say that the letter of comfort could become a moral obligation and not a legal one.
 

In some cases, the letter of comfort can become legally binding. Sometimes, the wording used in the letter could be interpreted in a way to force legal obligations and hence those issuing it are doubly careful.

A letter of comfort is different from a letter of guarantee. As spelled out in the name, the letter of guarantee acts as a commitment to the lender that the issuing company is taking responsibility for the repayment. It is also legally binding and the transaction becomes an obligation for the guarantor. Holding companies usually give letters of comfort when they are unable or unwilling to give letters of guarantees.

According to a recent report in a leading daily, loans worth thousands of crores are at risk of downgrade as the Reserve Bank of India disallowed letters of comfort provided by a corporate. The RBI has also directed all credit rating agencies to rely on explicit guarantees and not letters of comfort or support while assigning credit enhancement.