A Letter of Undertaking (LoU) is a financial document issued by one bank on behalf of a customer to another bank, guaranteeing payment of a specified amount. It acts as a form of bank assurance that allows an importer to obtain foreign currency loans from overseas branches of Indian banks for trade-related transactions. Essentially, the LoU serves as a payment guarantee between banks and facilitates smooth cross-border trade financing.

In India, the Reserve Bank of India (RBI) regulates the issuance and use of Letters of Undertaking to ensure transparency and prevent misuse. The LoU remains valid for a specific tenureótypically up to one yearófor import payments. During this period, the issuing bank is obligated to honor the payment if the borrower fails to repay. To issue an LoU, the bank assesses the applicantís creditworthiness, transaction history, and collateral, ensuring compliance with all foreign exchange and trade norms.

Following the high-profile misuse of LoUs in the 2018 banking fraud case, the RBI tightened its regulations. It restricted the use of LoUs and Letters of Comfort (LoC) for trade credits, emphasizing stronger due diligence and internal controls among banks. This step aimed to protect the financial system from fraudulent transactions and reinforce the credibility of Indian banking operations.

Today, businesses engaged in international trade must rely on legitimate instruments such as Letters of Credit or Bank Guarantees that comply with RBI and SEBI regulations. Understanding the concept of a Letter of Undertaking helps investors and traders grasp how credit instruments support trade finance while maintaining accountability and financial discipline within the banking ecosystem.