What is a comfort letter?

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In April this year, the Union Finance Ministry banned ministries and departments from issuing a letter of comfort. The idea was to establish transparency. And now the Reserve Bank of India has banned such a corporate-provided bank quasi-guarantee instrument. What is this document?

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A comfort letter is an accompanying document issued to a borrower that reinforces the transaction when granting loans. Comfort letters are generally issued by a third party or party to the transaction. For example, a holding company may issue a comfort letter on behalf of its subsidiary or a government may issue a comfort letter for public sector companies. The comfort letter can also be issued by banks, NBFCs and auditors.

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The comfort letter is not legally binding or an obligation for the holding company to repay the loans. It is simply an assurance to the lender that the holding company is aware of the transaction, the subsidiary’s policies and its intentions in seeking a loan. This allows the financial institution to lend money in the short or long term. It can be said that the comfort letter could become a moral and not a legal obligation.

In some cases, the comfort letter can become legally binding. Sometimes the wording used in the letter could be interpreted to force legal obligations and therefore those who issue it are doubly careful.

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A letter of comfort is different from a letter of guarantee. As stated in the name, the letter of guarantee acts as a commitment to the lender that the issuing company takes responsibility for repayment. It is also legally binding and the transaction becomes an obligation for the guarantor. Holding companies generally give letters of comfort when they cannot or will not give letters of guarantee.

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According to a recent report in a major daily, loans worth thousands of crores are at risk of downgrading as the Reserve Bank of India refused letters of comfort provided by a firm. The RBI has also ordered all rating agencies to rely on explicit guarantees and not letters of comfort or support when granting credit enhancement.

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First published: Tuesday, August 16, 2022. 07:00 IST

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