The term LoU or Letter of Undertaking has recently been in news in wake of the banking fraud concerning Punjab National Bank and Nirav Modi. A LoU is a provision of bank guarantees under which a bank can allow its customer to raise money from another Indian bank’s foreign branch in the form of a short-term credit. The LOU serves the purpose of a bank guarantee for a bank’s customer for making payment to its offshore suppliers in the foreign currency.
For raising the LOU, the customer is supposed to pay margin money to the bank that issues the LOU and accordingly, they are granted a credit limit. Once the letter of credit is acknowledged and accepted, the lender (the foreign branch of Indian bank) transfers money to the nostro account of the bank that has issued the LoU.