PNB Scam (22.02.18)

HOW SCAM OCCURRED?

How did the Punjab National Bank (PNB) scam work?

Diamond merchant Nirav Modi has been accused of siphoning off funds worth about ₹11,500 crore from the public sector bank, PNB. A key element of the scam is the Society for Worldwide Interbank Financial Telecommunication (SWIFT), a messaging network that connects banks and other financial institutions across the world. Among other things, a bank that is part of SWIFT can use the system to convey credit instruments called letters of undertaking (LoUs) to other banks located overseas. An LoU is simply a request made to another bank in the SWIFT network to loan money to a client. The bank that issues the LoU essentially guarantees the bank that receives the LoU request that it stands by the creditworthiness of the borrower. That is, in case of a default, the bank that issued the LoU stands liable to compensate the bank that made the loan to the borrower. PNB alleges that employees at one of its branches in Mumbai issued fraudulent LoUs that were not authorised by its management. This allegedly allowed Mr. Modi's companies to obtain loans from the overseas branches of various Indian banks.

Why did it happen?

PNB’s internal information systems were not seamlessly linked to SWIFT. It is claimed that the huge fund transfers made via SWIFT to Mr. Modi’s companies by a few PNB employees went undetected for many years. Many critics, however, contend that the fraud is not simply a matter of the failure of PNB’s internal control system. Instead, they blame flaws in the ownership of public sector banks. In fact, the PNB scam came to light only after a whistle-blower exposed it.

Is this the first time?

No. SWIFT has been gamed by miscreants on a number of occasions. In 2016, there was a cyber-heist of $81 million from Bangladesh’s central bank. Russia’s central bank recently reported that $6 million was stolen from a Russian bank last year by exploiting the SWIFT system. Even the Reserve Bank of India stated this week that it had privately warned Indian banks about the prospect of misuse of SWIFT at least three times since August 2016.

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A DEEPER MALADY: ON PNB FRAUD CASE

Barely days after news of the ₹11,500 crore fraud at Punjab National Bank broke, another but very different scam of a ₹3,695 crore wilful loan default has surfaced. The Central Bureau of Investigation has registered a case against three directors of a Kanpur-based company, and others including unknown bank officials, on allegations of cheating a consortium of banks by siphoning off loans disbursed to the company. If the two cases must be compared, the similarities lie in the breakdown in internal control mechanisms and in the supervisory failure at the banks. In the case of Kanpur-based Rotomac Global, it had availed credit limits from a consortium of seven public sector banks. Given that the facility was made available from 2008 (in the case of Bank of Baroda, which filed the complaint with the CBI), and was used for a range of seemingly unrelated transactions including the import of gems and jewellery and the export of wheat, it is especially surprising that it took such a long time for this diversion of funds to surface as a criminal complaint. It is one thing for individual bank officials to have been complicit in the commission of frauds as has been claimed in the PNB case but quite another for supervisory cadre and risk detection and management systems to have delayed taking remedial action as they did in the Rotomac case. It took too long for the criminal complaints to be filed against the defaulters. On Bank of Baroda’s website Rotomac was listed as its top defaulter almost a year ago; the account had been classified as an NPA in 2015.

In the case of the Punjab National Bank fraud, letters of undertaking were issued bypassing the bank’s reporting system; the three-tier audit failed to detect the malfeasance. In contrast, BoB was not oblivious of the Rotomac default and took unconscionably long to act. It is important to determine why the Reserve Bank of India, which is vested with keeping an eye on bank books, was unable to take prompt corrective action in this case. Rather than routinely reiterate the importance of strengthening corporate governance in public sector banks and promising to infuse greater professionalism, transparency and accountability, it is time the Centre, the major shareholder in these institutions, takes serious steps to translate this intent into action. Any improvement in the functioning of the PSBs cannot be undertaken without empowering bank managements and securing their independence from political interference while enforcing strict accountability for lapses. To restore the depositor’s faith in the banking system, the government, the RBI and the judiciary must ensure that prompt and salutary action is taken. The economic cost of doing otherwise is too painful to imagine.

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GEM OF A SCAM: ON PNB FRAUD

A regulatory filing to the stock exchanges by Punjab National Bank has blown the lid off a ₹11,500-crore fraud. Perhaps the largest such scam in India, it was perpetrated by a maverick diamond merchant in collusion with bank officials at a single branch in South Mumbai. For India’s second largest bank to be defrauded in the manner suggested is astounding, especially since there has been heightened scrutiny of public sector banks’ operations in the last few years. The bank’s audit committees and boards, as well as the central bank, which conducts routine financial inspections of banks’ books, have been ostensibly keeping a close watch on the loans that have turned substandard or are on the verge of default. The government, which has often blamed the pile of bad loans on crony capitalism during the UPA regime, just last month unveiled a plan to infuse about ₹1 lakh crore into 21 capital-starved public sector banks this fiscal. Of this, ₹5,473 crore is to be injected into PNB. So even if the actual loss the bank ends up incurring on account of this fraud is half the stated amount, its capital adequacy ratio will be back to the same level before the recapitalisation was announced. Its market capitalisation has tanked ₹8,077 crore over the past two days, with the share price falling over 20% since the news broke.

The bank’s top brass has said it has acted promptly, suspending around 10 officials. The Central Bureau of Investigation has booked one retired and one serving PNB employee so far. It is also difficult to believe that a handful of junior employees could orchestrate such a massive fraud. The bank’s managing director has claimed that supervisory lapses are being probed, and the Enforcement Directorate has initiated a money laundering case against the main accused, billionaire-jeweller Nirav Modi, his wife Ami Modi and close associates and relatives. The firms run by him had seen a meteoric rise and an IPO was in the offing after buyouts of global players and a ramp-up of retail presence in India and abroad. It appears that the bank employees who assisted in the fraud routed large transactions for the borrowers by circumventing the core banking solution. This flies in the face of the government’s push for a digital payment economy. PNB has sought to blame overseas branches of other banks for not undertaking due diligence before accepting such transactions, but that may be too simplistic an explanation. An inquiry by the RBI must get to the bottom of the systemic lapses in this affair and fix accountability across the chain of command. The banker-borrower nexus has been blamed for problems in the banking system for years. This episode will set off fears of a nexus deeper than imagined. The RBI and investigating agencies should act speedily to restore trust in the banking system.

(All of the above articles have been taken straight from The Hindu. We owe it all to them. This is just a small effort to consolidate opinions expressed in The Hindu in a subject-wise manner.)