The US$1.9 billion fraud unearthed at India's second-largest public sector bank will make letters of credit (L/Cs) harder to come by and more expensive for small- and medium-sized enterprises (SMEs) according to India Ratings and Research.

The Reserve Bank of India (RBI) recently decided to ban letters of undertakings (LoUs) and letters of comfort (LoCs) because officials of Punjab National Bank (PNB) allegedly issued these instruments to celebrity jeweller Nirav Modi to perpetrate the massive diamond trade fraud.

The move has forced more companies to seek L/Cs instead, but these may well come at too high a price for smaller or less creditworthy companies.

Liquidity pressure

The RBI's ban on LoUs and LoCs is likely to increase SMEs' net working capital requirements, which in turn will increase liquidity pressure on banks according to India Ratings.

It concludes that this is likely to lead to higher funding costs for SMEs.

Debt service pressure

Creditworthy importers unable to obtain LoUs or LoCs would be able to obtain reasonably priced alternative financing options but access to low-cost funding for SMEs will be impacted, the report said.

The ability of smaller importers to service their debt will also come under pressure according to India Ratings.

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