Letter of credit (LC) is an undertaking from a bank on behalf of its customer (importer/buyer) wherein the beneficiary (exporter) is fully assured of payment provided he fulfills his part of the sale contract embodied in Letter of Credit. Similarly, Co-acceptance of bills means “an undertaking from the third party (generally a Bank) to make payment to the drawer of the bill (seller/exporter) on due date even if the buyer/importer fails to make the payment on that date”. Since there is an undertaking from another bank for payment of the bill in either of the above type of bills; many bankers think that financing such bills is a safe advance.
Will the bank get back the money safely for the bills discounted/negotiated by it? For many, the answer sounds like obvious because another bank has guaranteed the payment on due date. However, if we look at the records of bank defaults, we may find that in umpteen numbers of instances, where on the maturity of bills, neither the drawees nor the bank which opened LC/ co-accepted the bill failed to make the payment on the due date as promised. For the experienced banker such defaults are not difficult to understand. Nowadays, many banks have been facing rough weather, being guilty of deficiencies in regulatory compliance or the account opened and bills purchased/discounted/negotiated in contravention of various directions and instructions of RBI as stated below.
Thus, some of the important precautionary measures to be undertaken by the discounting bank are itemized below.
- The lender bank shall obtain ‘no objection certificate’ from the other banks for purchasing/discounting/negotiating the bills if the borrower is enjoying credit facilities from other banks. Some bank branches who have not obtained NOC from the other banks, casually crediting the proceeds of bills to the current accounts of beneficiaries and the amount so credited to beneficiary’s account were transferred to other group accounts giving way to siphoning of funds financed by other banks. RBI has been imposing heavy penalties on such banks who have discounted/purchased the bills in contravention of RBI norms.
- The lender banks shall call for credit reports of not only of its borrower but also of the drawee (buyer) and ascertain the credit- worthiness and reputation of the buyer with regard to honor the bill amount on due date. The sanction of limits for co-acceptance of bills shall be subject to the buyer’s capability to pay and compliance with the exposure norms for individuals/group borrowers. In addition to above, the bills discounting Banks can refer the bulletins of IBA which show the names of unsatisfactory drawees.
- The lender bank before discounting the bills must ensure that the bills are genuine trade bills and not the house bills/accommodation bills drawn by group concerns on one another.
- The lender bank shall find out whether the LC opening/ co-accepting bank’s capacity to discharge its monetary obligations. The bills co-accepted by the fragile banks (of weak capitalization)/ the banks which are running in losses will not be able to discharge their commitments if the drawee (buyer) fails to make the payment on due date.
- There are many incidents came to light in the past that the branches not having the discretion to co-accept the bills on their own co-accepted the bills without the permission from the sanctioning authority. Some branches of the banks did not save the proper records of the bills co-accepted by them. In such incidents, matter comes to the notice of the controlling office when the branch is unable to discharge its obligation to the bank which discounted the bill. In view of the above, the discounting bank shall fix the bank-wise limits based on the size of each bank. The relative powers of the officials of the other banks to co-accept the bills should be got registered with the discounting banks.
- The lender bank shall advise the Head Office of the bank which has co-accepted the bills if it discounts/purchases the bills which exceed Rs.20 lakh for a single borrower/group borrowers and take their permission in writing.
- The valuation of the goods as mentioned in the accompanying invoice should be verified to see that there is no over-valuation of stocks.
- The amounts of bills presented for discount/purchase/negotiation shall match with the volume of business turnover of the borrower.
- The lender bank shall ensure that the drawer is dealing with the goods covered by the bills presented to them for finance.
- The lender bank shall ensure that the goods covered by such bills are subsequently received in the stock account of the borrower.
- The discounting/negotiating bank shall ensure that the bills are drawn at a place where the goods have been consigned.
- The negotiated /co-accepted bill of exchange/draft shall be drawn in favour of the financing bank.
- The description of goods cited in the invoice and bill of lading shall be the same.
- The bills shall not be financed if the goods are directly delivered to the buyer or if the goods are not properly insured or if the goods are of perishable nature or the price of the goods is volatile in the market or in the case of Usance bills which is not properly stamped or if the bill is stale.
- In case of Inland bills, the LR should be in the prescribed format of IBA.
- It is advisable to introduce a system by the discounting bank of obtaining periodical confirmation of the liability of co-accepting bank.
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