Standby L/Cs used to avert default

[JimBarnes]

I just read this and am trying to make sense of the reported transactions and their purposes. Any reaction?

Standby L/Cs used to avert default


By Mark Ford

18 February 2014

Standby letters of credit (L/Cs) are being used by Indian banks and companies as a tool to avert default, according the media reports.

A report in the Economic Times says that the practice is adopted particularly in respect of large borrowers in the steel, pharmaceuticals or energy sectors.

Likely default

According to the newspaper, a standby L/C is employed when both the lender and the borrower consider that default is likely.

The lender then issues a standby L/C on behalf of the company, promising to pay another bank if the company defaults on its payment obligations.

Discounted L/C

If this happens, the company uses a wholly-owned offshore subsidiary to discount the L/C at a foreign bank.

The proceeds of the discounted L/C are then sent to the company in India which then pays its loan obligations to the issuing bank.

According to the Economic Times, the practice is employed by some large public sector banks as well as some private ones.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.

[NigelHolt]

I am as puzzled as you Jim.

[Dennis]

I have been sitting in Florida puzzling over this scenario for nearly a month. I think its a slight of hand to repay the loan with "seemingly" new external funds from a different/new source i.e. the foreign sub. and foreign bank
It avoids default, pays the loan with supposed new money, and establishes a new obligation for the company to finance the LC drawing. The issuer/lender has no additional risk as it in essence is recycling funds. But the bank clears a bad loan off its books and establishes a seemingly new, unrelated one. Its akin to kiting in my opinion and is quite slick.
[edited 3/28/2014 12:57:51 AM: add word]