The composite scenario: Niradhar Diamonds, a Mumbai diamond trader with reputation in the trade, needs short-term overseas funding to buy rough diamonds in Antwerp and Tel Aviv. Their working capital line at a major Indian PSB ("PSB-X") covers part of it. For the rest — the bank issues Letters of Undertaking (LoUs): short-term guarantees to foreign branches of other Indian banks. Those branches give cash credit to Niradhar's importing company, backed by PSB-X's guarantee.
The fraud, simply put: the LoUs were issued via SWIFT but never entered into PSB-X's core banking system. Two mid-level officers at PSB-X's foreign-exchange department issued LoU after LoU, hidden from internal audit. Borrower companies funded by these LoUs rolled them over for years.
When the original officers retired, their successors couldn't replicate the SWIFT-only flow. Niradhar's overseas branches stopped getting fresh LoUs. The fraud surfaced in January 2018. Cumulative exposure: ₹13,000+ crore.
The Reserve Bank of India banned LoUs altogether by March 2018. Here's what changed.
- What an LoU was: a written commitment by one bank (issuing) to another (lending) — usually a foreign branch — guaranteeing repayment of a trade-finance loan. RBI-permitted under Master Direction on Trade Credit (pre-2018).
- The fraud mechanism: PSB officers issued LoUs over SWIFT (an inter-bank messaging system) without parallel entries in the bank's core banking system (CBS). External counterparts saw legitimate-looking guarantees; internal audit saw nothing.
- March 2018 ban: RBI's notification DBR.No.BP.BC.93/08.12.014/2017-18 prohibited issuance of LoUs and Letters of Comfort (LoC) for trade credits. Existing LoUs allowed to run off; no new ones.
- What replaced LoU: bank guarantees (with proper collateral + CBS entry), letters of credit (LC), and Trade Receivables Discounting System (TReDS) for receivables-backed funding. All have stronger audit trails.
- The wider fix: RBI mandated that all SWIFT messages must be reconciled with CBS by T+1; integration tightened; staff rotation in forex departments enforced; whistleblower mechanisms strengthened.
How the structure worked (and why it was so opaque)
Niradhar imports rough from Antwerp / Israel. Pays in USD. Needs working capital. His own Indian bank PSB-X has limited working-capital line. He approaches PSB-X for an LoU to access foreign-branch USD credit.
PSB-X sends a SWIFT MT760 (guarantee message) to, say, "PSB-Y Hong Kong branch", guaranteeing Niradhar's importing entity's USD borrowing of $10 million for 90 days. PSB-Y HK extends $10M to Niradhar's offshore importing arm.
The two officers at PSB-X handling the SWIFT terminal didn't enter the LoU as a contingent liability in the bank's books. From CBS perspective: no such guarantee exists. From audit's perspective: no exposure. From SWIFT's perspective + foreign branch's perspective: real, valid commitment.
At 90-day maturity, instead of repaying USD 10M, a fresh LoU is issued covering the same exposure + slight increase. The trader doesn't actually repay; the LoU stack grows. For 7+ years.
New officers at PSB-X take over the forex desk and don't replicate the off-CBS practice. Foreign branches stop getting fresh LoUs. The borrower can't repay (cumulative exposure ~₹13,000 cr). Foreign branches invoke PSB-X's guarantee. PSB-X realises the scale of unbooked exposure. Fraud surfaces.
Why the system couldn't catch it earlier
- SWIFT and CBS were not integrated in many Indian banks until 2018. SWIFT messages could be sent / received without automatic mirror entries in CBS.
- Forex desk officer concentration: same officers held the SWIFT terminal access for years. No rotation, no peer review.
- External audit didn't catch it: auditors checked CBS records; LoUs weren't in CBS, so they weren't audited.
- Foreign-branch reliance: the lending foreign bank trusted the SWIFT message as authoritative. No habit of cross-confirming with issuing bank's CBS-extracted exposure register.
- Borrower complicity: the trader knew the LoUs were off-books; arranged repeated rollovers.
What RBI did, March 2018 onwards
LoU / LoC ban
March 2018
Issuance of LoUs and Letters of Comfort for trade credits prohibited from 13 March 2018. Existing instruments could be honoured till maturity; no new issuance allowed.
SWIFT-CBS integration
T+1 reconciliation
RBI mandated all SWIFT inflows / outflows be reconciled with CBS records within T+1. Off-CBS SWIFT issuance technically impossible going forward. Implementation across PSBs: 2018-2020.
Approved alternatives
BG / LC / TReDS
Bank Guarantees (proper collateral + CBS entry) for trade credits. Letters of Credit (LC) for import financing with documentary controls. TReDS (e-platform for invoice-discounting). All have stronger audit + governance.
What an exporter / importer should actually use today
- Bank Guarantee (BG): traditional instrument. Bank holds collateral / margin from your account; issues guarantee to beneficiary. Recorded in CBS as contingent liability. Audit-visible.
- Letter of Credit (LC): payment-undertaking by issuing bank to seller-bank against documents (BL, invoice, packing list, CoO). For import financing. Standard UCP 600 framework.
- Buyer's Credit: short-term USD credit from overseas branch of Indian bank, backed by BG (not LoU). Cost: LIBOR + spread + BG fees.
- Supplier's Credit: extended payment terms from foreign supplier itself. Often interest-bearing.
- External Commercial Borrowing (ECB): longer-tenor (3+ year) overseas borrowing, RBI-permission required for large amounts.
- TReDS: domestic receivables-discounting electronic platform. For MSMEs with receivables from large buyers.
The criminal-side aftermath
Beyond the regulatory fix, the borrower / officers in the original scam faced:
- Fugitive Economic Offenders Act 2018: created specifically to deal with high-value economic offenders who flee India. Property attachment without conviction in absentia possible.
- Prevention of Money Laundering Act 2002 (PMLA): investigation by Enforcement Directorate, property attachment.
- FEMA contraventions: penalties up to 3x amount involved for foreign exchange irregularities.
- CBI investigation: criminal conspiracy + cheating + criminal breach of trust.
- Bank officer liability: arrest, suspension, disciplinary action.
- Extradition proceedings: in the iconic real-world cases, key accused fled India before arrest; UK/Belgian extradition proceedings have been protracted.
The LoU ban removed a legitimate trade-finance tool that many honest exporters / importers used. Replacement instruments (BG, LC, TReDS) are slightly more expensive, slower, and require more collateral. The system became safer at the cost of slightly less efficient trade financing. Smaller exporters felt this most — large traders had alternatives, small ones lost the LoU-route entirely.
What you should remember from this saga
- Trust but verify: any "off-system" financial instrument is a red flag. Even if it's offered by a bank officer, if it doesn't show up in your bank's online statement or your bank's CBS-extracted exposure register, it's not a real instrument from the bank.
- Annual audit your trade-finance exposure: every BG, LC, LoU (historically), ECB, supplier's credit — must reconcile to bank's confirmation letter at FY-end.
- Internal control: separation of duties: the officer initiating a SWIFT message should not be the same one authorising it.
- SWIFT audit independent: external auditor / internal auditor should sample SWIFT message logs and reconcile to CBS independently.
- For exporters / importers: pricing in BG / LC costs is now part of the deal. Don't try to get LoU-equivalent instruments; they no longer exist legally.
Quick answers
Existing LoUs ran off after March 2018 maturity. New trade-finance via BG, LC, or buyer's credit. Talk to your bank's trade desk for the appropriate instrument.
Buyer's credit = USD loan from foreign branch of Indian bank, for import payment. Needs underlying BG from Indian bank as security. BG alone = guarantee for performance / payment, no loan. Often used together.
Yes — BGs are recorded as contingent liabilities in your bank's statement and your books. Annual bank-confirmation letter to auditor lists all outstanding BGs. Audit-visible.
TReDS works for receivables from large buyers (annual turnover ₹500cr+). If your buyer is in the qualifying list, you can discount invoices through the platform. Faster cash, better rates than traditional bill-discounting.
Supplier's credit up to 12 months for goods: routine, RBI-approved. Above 12 months: needs ECB-route approval. Report via Form 83 / FCTRS as applicable. Your AD (Authorized Dealer) bank handles the paperwork.
When you might want help
Two situations: (1) Setting up a trade-finance line — BG / LC / buyer's credit comparison + bank negotiations. (2) Trade-finance compliance review — annual reconciliation of BGs to bank confirmation letters, FEMA-side disclosure for supplier's credits.
Trade-finance compliance question?
BG / LC structure + FEMA / RBI reporting + annual reconciliation. Fixed-scope.
"Niradhar Diamonds" and "PSB-X" are composite illustrations drawn from publicly known features of the 2018 LoU-fraud disclosure. No specific company or person is intended.