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The Decade of Frauds: Part 2: Punjab National Bank Scam

INTRODUCTION: When we ponder about storing our valuables and money, the safest and the most commonplace that strikes our mind is banks. And why not? They not only keep our property safe but also provide interest in certain cases. The efficient banking system is a necessity and backbone for the smooth operation of an economy. The Indian banking system has expanded over time but it has not always been far from challenges.

So the question arises, are they safe enough? No matter how unreal it might seem to commit fraud with banks, India is still suffering from it. Despite being argued as the most heavily regulated industry in the world, 53,334 cases of fraud involving an amount of Rs. 2.05 lakh crore has been reported by banks in the last 11 fiscal years, as per the central bank’s data. The scam with Punjab National Bank is the biggest of all.

DETAILS OF THE FRAUD: On 14th February 2018, Punjab National Bank (India’s second-largest public sector bank) unveiled to Bombay Stock Exchange (BSE) the biggest banking fraud in Indian history. A default of Rs.11400 crores, with the prime accused being one of country’s richest diamond merchant Nirav Modi and his maternal uncle Mehul Choksi.

PNB initially reported a scam of Rs. 280 crores on 29th January 2018, when it filed an FIR with CBI stating fraudulent LoUs were issued on 16th January. PNB named Diamond R US, M/s Solar Exports and M/s Stellar Diamonds (wherein Nirav Modi, his brother Neeshal Modi, his wife Ami Modi and Mehul Choksi were partners) in their complaint. PNB stated that Gokul Nath Shetty, retired Deputy Manager of Foreign Exchange department and Manoj Kharat, issued fraudulent LoUs to Hong Kong-based creditors. After further investigation, the figure was revised to Rs. 11400 crores on 14th February 2018. The scam was conducted over a period of 6 years (2011-2017) at Brady House Branch of PNB in Fort, Mumbai.

WHO IS NIRAV MODI?: Nirav Modi is the prime accused. Nirav Modi is a luxury diamond jeweler, designer, businessman, and founder of Nirav Modi Global Diamond House. His family has been in the diamond business for several generations. He is the Chairman of Firestar International and the parent of the Nirav Modi chain. With stores in Delhi, New York, London, etc., he was ranked 1234 in Forbes Billionaires list of 2017 and 85th in India. His net worth was estimated at $1.73 Billion, as per Forbes.

DETECTION OF FRAUD: When a set of partnership firms approached PNB on 16th January 2018, after the retirement of Gokul Nath Shetty(accused employee), and asked for LoUs to make payment to its overseas suppliers, the new employee asked for 100 percent cash margins. The firms argued that they had availed such a facility without any collateral for many years. However, the books revealed no such past transactions. This led to suspicion of fraud and the bank started digging information. The officials then discovered that Shetty and Manoj Kharat fraudulently issued LoUs in the past without following prescribed procedures and approvals.

ROLE OF LETTER OF UNDERTAKING: A Letter of Undertaking is a provision of bank guarantee under which a bank allows its customer to raise money from other Indian Bank’s foreign branches as a short term credit on collateral. In other words, a LoU guarantees an overseas bank (Foreign branches of Axis Bank, Allahabad Bank, Union Bank of India, UCO Bank in this case) that if it lends money for a specified period to client identified by the home bank (PNB in this case), then the home bank will assure that the entire sum of money will be returned to the overseas bank. The funds are then transferred to the NOSTRO Account of the home bank.

A NOSTRO Account is the account that an Indian Bank has with an overseas bank. Here, the overseas bank was not interested in what Nirav Modi will do with the amount as it had trust that PNB would repay it even if Modi went bankrupt. In this case, LoUs were opened for a period as long as one year, against the RBI guidelines of a total time period of 90 days. Modi made dummy individuals as stakeholders in the companies and didn’t convey the same to PNB. Instead, three current accounts were opened at Surat Co-operative Bank showing them as majority stakeholders. The Reserve Bank of India then scrapped LoU in March 2018.

HOW WAS BANK UNDER OBLIVION?: The process involved misusing the SWIFT network, (which is an international financial communication network for transmitting information through codes) to transmit information to foreign branches of Indian Bank. The entire transaction was never recorded in CBS (Core Banking System) by employees while issuing LoUs. This prevented the early detection of fraud. Further, in order to avoid suspicion, LoUs of smaller amounts were issued by SWIFT which was routed through CBS and as soon as the approvals were received, amendments such as enhancing the amount of LoUs were made. The amended LoU was then transmitted without recording on CBS. The fraud took place for six years and subsequent LoUs were used to repay money of earlier LoUs. As per a report, a total of 1213 LoUs were issued to companies of Nirav Modi, his relatives, and Nirav Modi Group and 337 LoUs were issued to Mehul Choksi, his relatives and Gitanjali Group.

WHO ARE TO BE BLAMED?: Apart from Nirav Modi and Mehul Choksi, there are other parties who played their part knowingly or unknowingly. How true does it sound when we argue that the auditors of PNB had no idea whatsoever and were not able to detect the fraud? Further, the overseas branch of Indian banks continuously overlooked the NOSTRO Account of PNB. There was negligence on the part of RBI such as lack of stricter loan norms. Gokul Nath Shetty was not transferred for eight years, despite the rules stating that an employee cannot remain in the same position of the same branch for more than three years. It cannot be denied that a lot of people right from the lower to a higher level were involved in the scam.

IMPACTS OF FRAUD: Out of the thirty-nine listed banks, thirty-four banks suffered a fall in share price as an immediate impact. Stocks of over Rs. 36,380 crores eroded and the BSE BANKEX lost 1.2%. As of PNB, Rs. 8,007 crores of investors were lost. Union Bank of India lost 5.8%, Allahabad Bank lost 9.9%, Axis Bank lost 3.4% and SBI lost 3.34%. The scam not only reduced the ratings of PNB but also directly hampered its credibility. It reported a net loss of Rs. 13,417 crores between January and March 2018. The fraud was approximately 49 times the net profit of the bank for Quarter 3 of the fiscal year 2017-18. Investors lost their confidence and doubts on transparency in business crept in.

ACTION BY THE GOVERNMENT: After the complaint, the government canceled the passports of Nirav Modi and Mehul Choksi. Officials searched Modi’s home, showroom and offices in Surat, Mumbai, and Delhi. The Enforcement Directorate (ED) seized gold, luxury cars, diamonds, bank accounts, mutual funds, jewelry and other properties that valued close to 6000 crores. CBI then approached Interpol for tracing Nirav Modi who is on its wanted list for charges on criminal conspiracy, money laundering, etc. from February 2018. The CBI registered a case of disproportionate assets against Gokul Nath Shetty and arrested various other officials involved in the scam. Whether government intervention could prevent such a scam earlier is questionable as to when Hari Prasad, an Entrepreneur had written a detailed letter to PMO (Prime Minister’s Office) in July 2016 informing about a huge scam similar to that of Vijaya Mallya (PNB Scam) the government didn’t take any concrete action.

CONCLUSION: Nirav Modi and his relatives escaped India in early 2018, days before the news of scam. He’s currently seeking political asylum in Britain. As per the latest report, Nirav Modi is in Wandsworth Prison since March 2019 and will remain in custody till 27th February 2020. A final hearing may take place on 11th May 2020 by the Westminister Magistrates’ Court.

“How are scams to be prevented in the future if internal members are corrupt? Why did PNB issue LoU to Nirav Modi without collateral?” are questions yet to be answered. Scams have been a problem for the banking sector, and therefore there is a dire need to evaluate and if required change the internal processes and take appropriate actions. Right from audit processes to interbank communication, all checks were compromised in this fraud. Stricter rules are required to increase the confidence of investors both at the national and international levels as India cannot afford another scam similar to that of Mallya or Nirav Modi.

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1 Comment

  1. Mallika Sarda

    Well written!

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