What is a LoU in Banking System, and related terms? - Seeker's Thoughts

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What is a LoU in Banking System, and related terms?


Issuance of LoU was banned in March by RBI after its misuse was detected in the Punjab National Bank (PNB)’s scam. Recently the parliamentary standing committee on commerce has sought immediate restoration of issuance of LoUs and LoCs with proper safeguards.

What is LoU?
Letter of Undertaking (LoU) --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 for Credit or a Guarantee. LoUs are used in international banking transactions.  LoU is issued for overseas import remittance (Money received from abroad) and involves four parties – an issuing bank, a receiving bank, an importer and a  beneficiary entity overseas. 
According to norms, the term of a LoU, and can be rolled over once for six months. Since LoUs are form of lending, they are typically backed by security.
What is CBS?
CBS refers to Core Banking System—Core banking system is a working way of Banks. Usually all branches of the banks are interconnected and the benefit is that, the customer can access all services of the Bank from anywhere in the world.
 What SWIFT ?
SWIFT is a very important in core banking system as when an LoU is issue the message of credit transfer is conveyed (tells) to overseas banks through the Society for Worldwide Interbank Financial Telecommunication (SWIFT) System.
In simple words, the SWIFT system records the message of all ongoing transactions between Bank at International level.  However, it only tells about the transaction but does not tell the money associated with the transfer.
This is a significant information as it gives the bank’s consent and guarantee.
To issue SWIFT, an official has to log in and fill up secret information such as the account number and SWIFT code.
 It generally has three layers of security – maker, a checker and a verifier within  the core banking system before it is issued.

 What is Letter of Credit?
 LoC --  A letter of credit is a letter from a bank guaranteeing that a buyer’s payment to 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 of remaining amount of the purchase.