An LoC is a document that provides some confidence that an obligation, such as interest servicing and loan repayment, will be met in the end. An LoC, however, is not a definite promise, unlike an irreversible guarantee.

Following two communiqués, the first from the Reserve Bank of India in April and the second from the Ministry of Finance in June, there is currently a lack of clarity on existing LoCs by public sector firms.

While authorising only state-controlled non-banking financial businesses backing infrastructure to issue LoCs for specific operations, a finance ministry regulation issued on June 10, 2022 said that "under no circumstances shall the liability under the LoC evolve on the government."

However, the central bank advice note to credit rating agencies stated that LoC (unlike guarantees) is simply a "diluted, non-prudent" support structure and, as such, cannot be used to prop up a loan's rating or lower the interest cost on a loan backed by an LoC.

According to the RBI, only LoCs which are as solid as a legally enforceable guarantee or where the structure - in the case of LoCs issued by PSUs - allows the liability to boil over to the sovereign in the event of default by the borrowing entity, are admissible support mechanisms for credit enhancement or rating improvement.