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4) What do you understand by LoU and LoC. Discuss their importance in modern finance.(250 words)

Topic-  Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

4) What do you understand by LoU and LoC. Discuss their importance in modern finance.(250 words)

The hindu




Why this question

The Parliamentary Standing Committee on Commerce has recently presented a report in which it has said that the Reserve Bank of India’s decision to discontinue the issuance of Letters of Undertaking (LoU) and Letters of Credit (LoC) for trade credit was a knee-jerk reaction to the Punjab National Bank fraud case and the facility should be restored at the earliest. It is thus important to discuss the meaning of LoU and LoC and to know their importance in modern finance.

Directive word

Discuss- This is an all-encompassing directive which mandates us to write in detail about the key demand of the question. We also have to discuss about the related and important aspects of the question in order to bring out a complete picture of the issue in hand.

Key demand of the question.

The question wants us to simply bring out the meaning of the two terms- LoU and LoC. It then wants us to discuss their importance in modern finance framework.

Structure of the answer

Introduction– write a few lines on the popularity of LoU and LoC in the international finance system.


  • Define  LoC . E.g A letter of credit is a letter from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.
  • Give a simple definition of LoU-e.g. An LoU is an assurance given by one bank to another to meet a liability on behalf of a customer. The LoU is akin to a letter of credit or a guarantee. LoUs are used in international banking transactions. An LoU is issued for overseas import remittances and involves four parties — an issuing bank, a receiving bank, an importer and a beneficiary entity overseas. Since LoUs are a form of lending, they are typically backed by security.
  • Discuss their importance in the modern financial system. E.g LoUs are important instruments that allow those in the import trade to transact their business. As an importer in India cannot simply buy dollars and send it abroad to make payments to his supplier, various instruments such as LoUs and Letters of Credit are required to carry out the transaction. LoUs, which are essentially a form of guarantee, have come to be a far cheaper and convenient way for importer to raise credit etc. Take the help of the articles attached to the question and other relevant material to from your answer.

Conclusion- Based on your discussion, form a fair and a balanced conclusion on the given issue.