Banks need board nod for issuing LoCs

The Reserve Bank of India (RBI) issued prudential guidelines for banks issuing letters of comfort (LoCs) to overseas regulators while seeking approval for establishing subsidiaries or opening branches in foreign countries as also to support certain activities of their subsidiaries in India. Banks will now have to get an approval from their board of directors to issue LoCs.

LoCs are intended to provide comfort to overseas and domestic regulators that the parent bank will support its foreign or domestic subsidiaries in case they face any financial problems in future.

These letters are also issued to rating agencies in India, which might be rating the issuances or products of the bank's Indian subsidiaries, in regard to availability of the parental support to the subsidiary. Such LoCs could entail an element of contingent liability on the part of the issuing banks.

Banks will now have to lay down a well-defined policy for issuance of LoCs, including the indicative cumulative ceilings up to which LoCs could be issued by the banks for various purposes.

The policy must provide that the banks will obtain and keep on record a legal opinion in regard to the legally binding nature of the LoC issued. The banking regulator has directed banks to put in place an appropriate system for keeping record of all the LoCs issued.

The bank issuing the LoC will have to make an assessment of the likely financial impact on it, if called upon to support its subsidiary in India or abroad, as per the obligations stated in the LoCs.

The assessment made should be reported to the board, at least once a year. As a first time exercise, banks will have to conduct an assessment of all the outstanding LoCs issued as of March 31, 2008, and the results will have to be placed before the board in the ensuing meeting.

"Any LoC that is assessed to be a contingent liability of the bank by a rating agency, internal or external auditors, internal inspectors or the RBI inspection team, shall be treated, for all prudential regulatory purposes, on the same footing as a financial guarantee issued by the bank,'' said the RBI.

Banks will have to disclose full particulars of all the LoCs issued by them during the year, including their assessed financial impact, as also their assessed cumulative financial obligations under the LoCs issued by them in the past and outstanding, in its published financial statements, as part of the notes to accounts.