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Knowing this LC rule might save

your career one day
 April 16, 2017  Sandeep Maddu  9 Comments

Letters of Credit are not handled by every credit officer. So this article might
seem irrelevant to most of you. But wait!

One of the most important personal strategy that a credit officer should adopt is
to know the various ways in which his career can be jeopardized. Account issues,
frauds, financial indiscipline generally follow a particular pattern. Being aware
of these will help you should the day come when you actually face such a
situation.

So even if you do not have any accounts with LC limit, read on. Some day, one of
your borrowers might request for an LC limit or there might be a takeover
account from another bank which has LC limits and you get suddenly exposed to
LC limits.

So keep the following at the back of your head whenever you deal with LC limits.
Of late, there is a peculiar system being followed by banks in regard to LC limits.
Normally, LC is a non-fund limit, so no funds are involved. It is all based on
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paperwork. The LC is opened, goods are shipped, goods are received, usance 
given and on due date payment is made by the buyer. Everything works fine. The
problem arises when payment is not made on due date.

On the due date, if the borrower does not arrange funds for payment, as a banker
you normally give some grace time say 3 days and even then if the payment is
not made, the LC is said to be devolved. But the bank makes the payment since it
is a question of bank credibility. Then the bank follows up with the borrower.

The operational procedure used to be as follows. Say the customer has a CC

account with limit Rs. 500 lakh and it is fully availed. Say an LC is devolved. The
LC payment is Rs. 100 lakh. So banks debit the CC account.

If you have not worked with LCs before, you may ask how can they do this when
the limit is fully utilized. Doesn’t the CC outstanding now become Rs. 600 lakh
as against sanctioned limit of Rs. 500 lakh? Yes, that’s true. But as a banker we
do not have any other option. That Rs. 100 lakh pending payment has to be
captured somewhere. So we debit the CC account and start following up with the
borrower for regularization of the account.

One good thing about this procedure is that normally overdrawn accounts are
monitored by controlling offices and Head Office. So if you are at branch level,
even though your Circle Office/ Zonal Office/ Head Office keeps pressurizing you
to recover the amount, you are atleast safe in one aspect that nobody can
question you for laxity in followup. You keep talking to the borrower, you build
up correspondence proof such as letters to borrower and even your Zonal Office
may step in and speak with the borrower. In this way, as a branch manager or
advances officer at branch, you are in a relatively safe position.

However, in the recent past, a new procedure is being followed in some cases.
The problem for banks in the above case is there is risk of account being
classified as NPA. If the CC account is continuously overdrawn, there is risk of
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NPA classification. To avoid such problem, one practice being followed is instead
of debiting LC devolvement to CC account, a separate CC account is opened and
LC outstanding is debited to that new CC account.

For example, say LC of Rs. 100 lakh was devolved on 15.04.2017. The CC limit is
fully availed with outstanding at Rs. 500 lakh. In normal practice, CC account is
debited so CC outstanding is Rs. 600 lakh. Now, by the new practice, CC
outstanding is still Rs. 500 lakh and is in order. The new CC account outstanding
is Rs. 100 lakh.

  earlier practice     new practice

CC Remarks regular CC new CC Remarks

outstanding account account

outstanding outstanding

14.04.2017 500 account in 500 - account

order in order

15.04.2017 600 overdrawn 500 100 account

in order

By this practice, the regular CC account continues to be in order. For the new CC
limit, they are trying to close within 90 days. The thinking here is, a facility
becomes NPA if not paid within 90 days from date of availment.

Here lies the danger. Auditors are not accepting this and proceeding to classify
account as NPA. They are not accepting the argument that account is to be NPA if
dues are for more than 90 days from availment.
The key point here lies in RBI Master Circular on “Prudential norms on Income
Recognition, Asset Classification and Provisioning pertaining to Advances”
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(Link : RBI master circular on IRAC norms) 
Point 4.2.7 spells out a key point in this regard :

4.2.7 Asset Classification to be borrower-wise and not facility-wise

i) It is difficult to envisage a situation when only one facility to a

borrower/one investment in any of the securities issued by the borrower
becomes a problem credit/investment and not others. Therefore, all the
facilities granted by a bank to a borrower and investment in all the
securities issued by the borrower will have to be treated as NPA/NPI and
not the particular facility/investment or part thereof which has become
irregular.

ii) If the debits arising out of devolvement of letters of credit or invoked

guarantees are parked in a separate account, the balance outstanding in
that account also should be treated as a part of the borrower’s principal
operating account for the purpose of application of prudential norms on
income recognition, asset classification and provisioning.

In the above example, by applying this principle, CC outstanding is to be taken

as Rs. 600 lakh.
In problematic accounts, what usually happens is CC is overdrawn due to excess
drawals or some other reason.

Consider a typical example in these cases :

Today is statutory audit – 15.04.2017

 CC account of Rs. 500 lakh is continuously overdrawn from 10.01.2017
onwards. On 10.04.2017 this will become NPA. So you somehow convince the
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borrower to bring the outstanding within limit by arranging some 
temporarily funds. So on say 08.04.2017, the borrower brings some funds
and brings account into order and outstanding is Rs. 495 lakh.
Also assume there was an LC devolvement of Rs. 100 lakh in this account.
The LC devolved on 21.03.2017 and branch instead of debiting CC account,
opened a separate account. Branch’s logic is 90 days time is there from that
day i.e. 19.06.2017 for it to be NPA
So on audit day, branch feels that main CC account is in order since it was
brought within limit on 08.04.2017. It also feels that 90 days time is there
upto 19.06.2017 for LC devolvement to be classified as NPA. Today statutory
audit date is just 25 days from LC devolvement
But this is wrong
The auditors will calculate as follows
If the debits arising out of devolvement of letters of credit or invoked
guarantees are parked in a separate account, the balance outstanding in that
account also should be treated as a part of the borrower’s principal
operating account for the purpose of application of prudential norms on
income recognition, asset classification and provisioning.
So even though CC outstanding is Rs. 495 lakh on 08.04.2017, but on that
day LC devolvement in separate account is outstanding at Rs. 100 lakh. So
actual outstanding is Rs. 495 lakh + Rs. 100 lakh = Rs. 595 lakh.
Now, the account is overdrawn from 10.01.2017 till today 15.04.2017, which
is 95 days, hence account is to be classified as NPA

If you have not encountered LC limit, all the above might seem confusing to you.
But keep this at the back of your mind. If you handle LC limits, definitely keep
this in your mind. We all know that in every branch there are some problem
accounts. They keep doing things like bringing outstanding within limit just
before balance sheet date and again account is overdrawn. There are always
some parties like that. If such parties also have LC limit, it is likely that such
indisciplined accounts will also have LC devolvements at some stage. In such
cases, do not forget the above discussion. Always add the LC devolvement
outstanding also to main CC account and then see whether the combined
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outstanding is continuously overdrawn for nearing 90 days. In such a case, 
immediately follow up with party for regularizing the account.

The consequence for an account being classified as NPA is very severe these
days. One, your bosses at controlling offices will pound you. That is because
NPAs are very severely monitored all the way upto CMD, Finance Ministry and
RBI. So NPAs are not tolerated. Two, at your branch level, you will take a hit on
profit. A 15% standard provision on substandard asset, on a Rs. 5 crore LC
devolvement, will straight away knock off Rs. 75 lakh from your branch profit
which is a huge blow to your performance appraisal. Three, you will most likely
be faulted with laxity in monitoring and inadequate follow-up. So as a credit
officer, it is in your best interest to be aware of this crucial RBI guideline.

 Filed Under: Credit topics

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Comments
Sindhu Sagar S says
April 16, 2017 at 8:10 pm

Thank you for the useful info.

Reply

Jyoti Sharma says

February 17, 2020 at 9:40 am

Great!
Very useful content

Reply

Shakti Sinha says

February 24, 2018 at 10:20 pm
Very nice article really easy to understand

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Reply 
Sandeep Maddu says
February 25, 2018 at 7:44 am

Thank you. Glad to know it was helpful to you

Reply

Vivek S says
April 23, 2018 at 6:39 pm

Great article. Very clearly given information. Can you please share me your
contact number

Reply

Vivek Ganvir says

March 13, 2019 at 12:50 pm

Very well explained… thank you.

Reply
 GAURAV SHARMA says
April 3, 2019 at 11:53 am
CREDITAPPRAISAL.IN 
Thanks a lot for the lovely article. This is a bog help for people like me who are
new to credit.

Reply

Akshay says
July 10, 2019 at 8:57 pm

Nice explanation.. can u suggest any RBI or equivalent institution

guidelines/circular pertaining to LC (foreign )

Reply

Rajesh Kumar says

July 15, 2019 at 10:44 am

Very informative….clear and precise

Reply

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