Country’s second largest public sector lender, Punjab National Bank (PNB), is now in the middle of a ₹ 11,400 crore case of fraud transaction. On the morning of 14th February 2018 , PNB stunned the country’s financial sector when it informed the Bombay Stock Exchange (BSE) that it has detected some unauthorised and fraud transactions worth $ 1.77 billion (about ₹ 11,400 crore) at one of its Mumbai branches.

This case of PNB fraud, by far the biggest ever detected by an Indian bank, comes to light at a time when lenders, especially the public sector banks ( PSBs ) are hobbled by ₹ 10 trillion in bad loans on their books, a problem that has choked new lending and hurt the country’s economic recovery.

Meanwhile, PNB register a complaint to the Central Bureau of Investigation (CBI) against billionaire diamantaire Nirav Modi and a jewellery company alleging fraudulent transactions worth about ₹ 11,400 crore. This is in addition to the ₹ 280 crore fraud case that he is already under investigation for, again filed by PNB.

What is the allegation in PNB fraud case ?

On 29th of January 2018, a PNB official from Mumbai filed a criminal complaint with India’s federal investigative agency against three companies and four people, including Mr. Nirav Modi, a high-end jeweller and Mr. Mehul Choksi, the managing director of Gitanjali Gems Ltd, saying they had defrauded the bank and caused a loss of ₹ 280 crore.

The bank alleged that two junior employees at the Mumbai branch had helped the companies and people managing them get “letters of undertaking” (LoUs) from it without having a sanctioned credit limit or maintaining funds on margin. The LoUs were used to obtain short-term credit from overseas branches of other Indian banks, PNB said.

A letter of undertaking (LoU) is a service whereby the bank guarantees a customer’s payment obligation, of a specified amount, to a third party (say another bank), in accordance with terms and conditions stipulated in a contract. LoUs are used in international banking transactions. An LoU is issued for overseas import remittances. This transaction involves four parties: A local issuing bank, an overseas receiving bank, an importer and a beneficiary in overseas.

Based on the complaint, the Central Bureau of Investigation (CBI) registered a preliminary case against the companies and the people named on 31st January, 2018 and PNB also started said a detailed probe on these transactions.

On 14th February, PNB said in a regulatory filing that it had discovered fraudulent and unauthorised transactions totalling ₹11,400 crore at the Mumbai branch. Investigators have said the latest disclosure was related to the earlier case filed.

How the PNB fraud case was detected ?

According to the complaint filed by PNB with the CBI on 29th January, the fraudulent issuance of Letters of Undertakings (LoUs) was detected at the Mid Corporate Branch, Brady House in Mumbai.

A set of partnership firms, Diamond R US, Solar Exports and Stellar Diamonds, approached the bank on 16th January, with a set of import documents and requested for buyers’ credit to make payments to overseas suppliers. The firms have Mr. Nirav Modi, his brother Mr. Nishal Modi, Mr. Nirav’s wife Mrs. Ami Nirav Modi, and Mr. Mehul Chinubhai Chokshi as partners.

Buyers’ credit is, typically, a short-term loan facility extended to an importer by a bank to finance goods and services. It is a common mode of transaction in international trade where a bank extends credit to the importer and a finance agency based in the exporter’s country guarantees the loan.

As there was no sanctioned limit in the name of the firms, the branch officials requested the firms to furnish 100 % cash margin for issuing the LoUs for raising the buyers’ credit. At this, the firms argued that they had used such facilities in the past without keeping any money on margin. On scanning through records, PNB found no trace of any transactions.

On digging further, the bank officials discovered that two of its junior employees had fraudulently issued LoUs in the past without following prescribed procedures and approvals. The employees had then transmitted SWIFT instructions to the overseas branches of Indian banks for raising buyer’s credit without making entries in banking system to avoid detection. Such transactions went on for years without detection.

SWIFT is an interbank messaging system used by financial institutions to securely transmit instruction. As per the FIR, five of the SWIFT messages were issued to Allahabad Bank in Hong Kong and three to Axis Bank in Hong Kong.

Banking sources have said in some banks the SWIFT system and the core banking system work independently of each other. In PNB’s case, the outstanding LoUs were not available on its core banking system run on Infosys’s Finacle software, thus the LoUs issued went undetected.
The complaint also said that the funds so raised for the payment of the Import Bills have not been utilised for such purposes in many cases.

Who are the people and companies accused or involved in the PNB fraud case?

PNB has accused three partnership firms, Diamond R US, Solar Exports and Stellar Diamonds and 4 people on fraud case to CBI. The firms have Mr. Nirav Modi, his brother Mr. Nishal Modi, Mr. Nirav’s wife Mrs. Ami Nirav Modi, and Mr. Mehul Chinubhai Chokshi as partners.

Let’s look into detail of these personalities

Nirav Modi

Mr. Nirav Modi is a high-end jeweller who runs his eponymous Nirav Modi stores that spread from New York to Hong Kong. Nirav Modi is worth $ 1.73 billion according to Forbes rankings.

Nirav Modi, 46, is a regular feature on the lists of rich and famous Indians since 2013. He is a quintessentially sharp Gujarati entrepreneur, dead serious about building a global empire. The selection of his models, stores or even roping in former Facebook country head Krithiga Reddy as an advisor underscores that burning ambition.

Nirav Modi was among the first to supply diamonds according to client specifications in the 1990s, assorting them by size, colour, weight and size to enhance the buying experience; the earliest to sense the shift in global manufacturing bases from Europe to Asia or even the importance of retail. The jewellery brand was thus a natural progression.

In 2005, he bought into Frederick Goldman, his biggest customer in the US, that was then seven times his size. This in turn gave him a direct access to outlets like JC Penny, Sears and even a Walmart. Two years later, Nirav Modi expanded his US distribution through a majority partnership in Sandberg & Sikorski, a vendor to the US Armed Forces and owners of the 120-year-old luxury bridal jewellery brand, A Jaffe. Till date, his shopping bill is a neat $ 50 million and with his eyes on the luxury watch market, most expect more.

Within a span of a decade, and emerging out of nowhere, it has blazed its trail across high streets of Madison Avenue or MGM Macau and Marina Bay Sands to emerge as the biggest luxury label to have ever come out of Asia. Till the law caught up with him.

Nirav Modi’s companies colluded with the PNB bank staff, adding that it suspected some officials at foreign branches of other Indian banks that extended credit were also involved.

Nirav Modi, who is believed to be in Switzerland, was also present in a group photo of Indian CEOs with Prime Minister Narendra Modi, issued by the Press Information Bureau, in World Economic Forum on 23rd January, six days before the bank sent its first complaint against him to the CBI.

Mehul Chinubhai Chokshi

Mehul Choksi, Modi’s maternal uncle and his mentor in jewellery trade, was named in the FIR filed by PNB earlier this month with the Central Bureau of Investigation (CBI) for allegedly cheating ₹ 280 crore.

Choksi joined jewellery business in 1975 when he took the reins of Gitanjali from his father. He showed the ropes of diamond trade to Nirav Modi during a decade-long apprenticeship. Following this, Modi went on to establish his own business.

While Gitanjali Gems started out with trading in rough and polished diamonds exclusively, Choksi soon realised that even though it had made the company one of the largest exporters of raw diamonds across the world, this wouldn’t be getting him the profits that he desired.

Choksi was successful in entering the international market and expanding his business. Soon enough, he turned towards building a product-portfolio, as a result of which brands such as Gili, Nakshatra, Asmi, D’damas, Maya, Diya and Sangini came under his purview.

In 2006, the company acquired Samuel Jewelers Inc and the 111 high-end stores that came under it. As a result of this, they managed to get direct access to the US retail market.

Earlier this month, Gitanjali Group had issued a statement, saying that its chairman and managing director is being falsely implicated in the cheating case. This was after a FIR was filed by CBI accusing Choksi and three others of cheating PNB of ₹ 280 crore. The company said that it will take legal steps to have its Choksi’s name omitted from the FIR.

Others Involved

Other persons involved in PNB fraud case are Nirav Modi’s brother Mr. Nishal Modi, and his wife Mrs. Ami Nirav Modi. The billionaire jewellery designer, Nirav Modi is an India citizen but his brother Nishal and wife Ami are not Indian nationals. Nishal is a Belgian citizen and wife Ami is a US citizen. Two bank officials, Gokulnath Shetty (now retired) and Manoj Kharat, who were also named in the FIR as accused.

Nirav Modi had left the country on January 1st much before the CBI received a complaint from PNB on January 29th about a ₹ 280 crore fraud. His brother Nishal also left the country on January 1st, while wife Ami and business partner Mehul Choksi, the Indian promoter of Gitanjali jewellery chain, departed on January 6th.

Why PNB fraud case could happened?

The $ 1.8 billion fraud at the government-owned PNB shows the failure of various kinds of audits in the Indian bank, including the RBI’s inspection.

The Reserve Bank of India has to carry out a deep investigation, forensic audit of the accounts involved in the alleged fraud and also make it compulsory for the banks to carry out forensic audit.

Broadly the kinds of audits or inspections that are carried out in our Indian banks are :

  • Statutory Audit : Carried out by auditors appointed by banks. The statutory auditor is mainly a test check auditor or an audit where transactions are checked at random.
  • Concurrent Audit : Carried out by outside auditors at the bank branches,
  • Internal Audit : Carried out by bank staff
  • Inspection by RBI officials : The Reserve Bank of India has to carry out a deep investigation, forensic audit of the accounts involved in the alleged fraud

It is strange, in spite of these many audits, how the fraudulent transactions that have been carried out since 2011 were not detected. Normally large value transactions should be checked and SWIFT system transactions should be carefully checked.

Also, a Letter of Credit should normally be given only against receipt of security but it is not done in banks. The PNB case is just one bank and one branch. It is not known how many more banks and branches are involved in such transactions.

Thus, the alleged fraud in PNB is a failure of auditors, both internal and statutory and also of the regulator. The sad part is that everybody involved in such frauds in India know that nothing would happen to them.

What are the authorities doing in PNB fraud case?

A look out circular is issued by enforcement agencies to all exit and entry ports to inform them about the movement of an accused.

Federal investigators swung into action on Thursday, conducting searches at PNB branches and also at Nirav Modi’s home and offices. The CBI raided the residences of Modi, his brother, wife and Choksi, all partners of Diamond R US, Solar Exports and Stellar Diamonds and two bank officials, Gokulnath Shetty (now retired) and Manoj Kharat, who were also named in the FIR as accused.

The Enforcement Directorate, which investigates frauds involving foreign exchange transactions, was also conducting a probe. They conducted searches in several properties linked to billionaire jewellery designer Nirav Modi in Mumbai, Delhi and Gujarat on 15th february, and seized diamond, jewellery and gold worth ₹ 5,100 crore. The ED filed the case under the Prevention of Money Laundering Act (PMLA) after going through a CBI FIR registered on 29th January by PNB.

The PNB suspended 10 of its employees and sought documents from foreign branches of banks, including Allahabad Bank and Axis Bank.

The finance ministry has issued an advisory to all banks to review their large customer exposures.

Who assumes the liability of PNB fraud case?

PNB has said the transactions are contingent in nature, and it will decide on the liability based on the law and the genuineness of underlying transactions.
Banking sources have said several other banks who have extended loans based on the PNB LoUs that were later found to be fraudulent are at risk of losing money.

Some of the banks say PNB is liable to pay since it issued the LoUs, although PNB, in a 12th February caution notice addressed to chief executives of 30 banks, including two foreign banks, said the other banks also have a share in the blame as they overlooked certain Indian central bank rules.

It also said none of the overseas branches of India based banks had shared with PNB any documents or information at the time of extending buyers’ credit to the companies.

PNB said Nirav Modi had written to the bank but had yet to offer any formal proposal for a repayment.

What is the impact of PNB fraud case ?

These are the major impact of PNB fraud case:

Impact on Market

Following the announcement, PNB shares crashed 10 % intraday on 14th February eroding close to ₹ 4,000 crore investor money considering the magnitude of the scam which is nearly 1/3rd the market capitalization of PNB.

Gitanjali Gems shares declined 20 % to ₹ 37.55 after the company came under scanner of various investigating agencies following PNB fraud case. Also, Bombay Stock Exchange has sought clarification from Gitanjali Gems on 15th January after their name surfaced in the money laundering case. The jewellery retailer is yet to respond to these notices.

It calls for stronger checks and balances at banks particularly because recurring of such incidents can significantly damage investor confidence in these institutions.

Impact on PNB

According to the complaint, the LoUs were issued for the overseas branches of Allahabad Bank and Axis Bank, post which these banks have given money to the beneficiary entity on behalf of Modi’s firms. As a result, (as per Hong Kong Monetary Authority norms) PNB will have to settle the LoUs with these branches. This may result in higher provisioning for the next few quarters in PNB’s books if it is unable to recover the money.

Impact on other banks

With no assurance from PNB that it will honour the fraudulent guarantees, financing banks will find themselves stuck for payment. Bankers fear a legal stalemate as those who purchased loans in the secondary market will approach the financing banks.

PNB fraud have an impact on other lenders as well as suggested in the bank’s communication to exchanges. Only a thorough investigation will reveal the extent of the damage. It’s time for regulator and banks to work on better counter-fraud tools as recurring frauds can shake the faith of investors in these institutions.

What will happen now after disclosure of PNB fraud case?

One of the worrying aspects of the scam is that based on the fraudulent transactions, other banks appear to have advanced money to the customers abroad. PNB said that these transactions are contingent in nature and any liability arising out of these on the bank will have to be decided based on the law and genuineness of underlying transactions.

According to Lok Rajan, Joint Secretary in Department of Financial Services, this is not out of control or too big a worry at this point. That is his broad sense.

However, the ₹ 11,400 crore scam comes at a time when the Central government is attempting to provide a breather to ailing PSBs, having announced a ₹ 2.11 lakh crore capital infusion to the sector in October 2017.
As of now, experts opined, the only good that could come out of the affair would be some fresh consideration to implementing better practices in public sector banking.

How PNB fraud case exposes the biggest flaws in the Indian banking system ?

Indian banks are being hit with one disaster after another. India’s banking sector is already reeling under multiple woes of non-performing assets (NPAs) and lack of liquidity post demonetisation, corporate quarters now have a new scam to discuss about.

Recently, the Indian government in October 2017 unveiled a plan for massive capital infusion of INR 2.11 lakh crore into PSBs to strengthen the lending capacity and improve credit growth among PSBs that are saddled with a heavy, non-performing assets (NPAs) as well as are struggling to meet capital adequacy ratio by FY-2019. Many such moves are being taken in past to uplift the Indian banking system as they are extremely critical for the slowing Indian economy, as private investments remain elusive due to the serious problem of a twin-balance sheet.

The PNB fraud case, the elaborate web of deception has served to expose the other big flaws in the Indian banking system i.e., weak risk management practices and glaring over sight lapses.

Doubts are now being raised in several quarters as to how PNB officials at Mumbai’s Brady House branch continued to issue LoUs against import receipts from Mr. Nirav Modi and his firms for seven long years without attracting management supervision.

According to the Central Vigilance Commission rules, organisations and their chief vigilance officers are mandated to identify people working in sensitive positions and ensure that they get transferred every two to three years. International banks require their officers to go on vacation when peer review is conducted, however, Indian banks haven’t adopted such practices yet.

The PNB branch manager in question was in the same position for about seven years until he retired in January and handled one account for all these years, underscoring the lacunae in risk management and oversight functions at Indian lenders. It is difficult to believe that the knowledge of malpractices remained confined to a handful of people. It demonstrates the failure in management supervision in Indian banking system.

India’s socialist rulers nationalized the banks in 1969 precisely because they thought they were set up to favour the rich; it’s long been clear that state ownership has only made the problem worse. It is no coincidence that most of these outsize loans and egregious frauds were made to those with solid political connections of one kind or another.

While international banks tightened supervision and corporate governance after the subprime credit crisis in 2008, most Indian banks still appear to have remained laggards. No capital infusion and digital reforms can help Indian banking system without adopting a strict supervision and transparent corporate governance.

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