The Indian government has extended its practice of issuing state guarantees, traditionally provided to state-owned commercial banks (SoCBs), to include private commercial banks (PCBs).

This policy shift aims to enhance the creditworthiness of PCBs, enabling them to secure better terms in international trade finance, particularly for letters of credit (L/Cs).

Background

Historically, SoCBs in India have benefited from state guarantees, bolstering their credibility in global markets. These guarantees assure foreign exporters and financial institutions of the Indian government's backing, thereby facilitating smoother international transactions.

Recognising the pivotal role of PCBs in the economy, the government has now decided to extend similar guarantees to them.

Enhanced L/C credibility

With state guarantees, L/Cs issued by PCBs will carry the assurance of the Indian government. This added layer of security makes these L/Cs more acceptable to foreign beneficiaries, potentially leading to increased international trade facilitated by PCBs.

State guarantees can also enable PCBs to negotiate more favourable terms with correspondent banks, including reduced confirmation charges and lower interest rates on trade finance products. This competitive edge should allow PCBs to offer more attractive financing solutions to their clients.

Risk mitigation and RBI caution

The backing of state guarantees reduces the default risk associated with L/Cs issued by PCBs. This assurance encourages more exporters to accept L/Cs from a broader range of Indian banks, diversifying their banking relationships and reducing dependency on SoCBs.

While state guarantees bolster credibility, PCBs must adhere to stringent guidelines set by regulatory authorities. The Reserve Bank of India (RBI - central bank) mandates that banks exercise due diligence when issuing guarantees, ensuring that customers have the capacity to fulfil their obligations.

Impact

The extension of state guarantees to private commercial banks marks a significant development in India's banking sector.

This move is poised to enhance the global standing of PCBs, fostering increased participation in international trade finance and contributing to the overall growth of the economy.

This article represents the views of the author and not necessarily those of the ICC or Coastline Solutions.