Punjab National Bank hit by Rs 11,400-crore fraud: Here’s what we know so far

Feb 20, 2018 06:32 PM IST

A set of fraudulent transactions linked to billionaire jeweller Nirav reported by PNB, have now swelled to nearly Rs 11,400 crore. Here’s an explainer on what the PNB fraud case is all about.

On 14 February, state-owned Punjab National Bank (PNB) disclosed that it has discovered $ 1.77-billion (around Rs 11,400 crore) worth of fraudulent transactions at one of its Mumbai branches. In a complaint to the Central Bureau of Investigation, the lender named firms and people associated with billionaire jeweller Nirav Modi to connived with some of its officials to defraud the bank using bank guarantees. For those who came late, here is a primer based on CBI’s first information reports and public information available so far:

Men walk past Punjab National Bank (PNB) in Mumbai on February 14.(AFP File Photo)
Men walk past Punjab National Bank (PNB) in Mumbai on February 14.(AFP File Photo)

What is the fraud about?

Two PNB employees sent unauthorised letters of undertakings (LoUs), essentially bank guarantees, to foreign branches of Indian lenders, on behalf of firms related to Nirav Modi and the Gitanjali Group. The LoUs basically told these other lenders: Lend money to Nirav Modi firms so that they can pay for their imports. If they don’t pay up, we will make good this payment.

What’s irregular about this?

In the normal course, when an importer goes to a bank to ask for such a guarantee, one of two things happens. One, the bank asks him for collateral before it gives a guarantee. This collateral could be property in his name, or a fixed deposit with the bank. Second, the bank sanctions a credit limit. That means it will evaluate the importer (just like a lender asks for your income proof and address proof before giving you a home loan) and says he is good to be given a loan for a certain amount; but no money actually changes hands.

As probe into PNB case widens, a look at what led to the loan fraud
1: Nirav Modi leaves India
6: Mehul Choksi, Modi’s uncle and head of the Gitanjali Group, leaves India
16: Nirav Modi group representatives approach PNB’s branch seeking issuance of letter of undertakings for raising buyer’s credit. New set of bank officials insist on cash margins, which the group contests
16-24: Closer scrutiny of books shows earlier letters of undertaking (LoUs, essentially guarantees) issued to the group firms made without entries in bank’s books and without supporting documentation. PNB holds a series of meetings with the firms, asking them to pay the amounts and provide necessary documentation related to the imports
25: First set of LoU liabilities related to 3 Modi group firms amounting to Rs 281 crore mature
29: PNB files a fraud complaint against Modi group firms with RBI. Moves to register FIR with CBI
4: CBI issues lookout notice against Nirav Modi
5: PNB informs stock exchanges about the Rs 281 crore fraud involving the Modi group
7: PNB files fraud complaint against the Mehul Choksi promoted Gitanjali group companies with RBI for Rs 65 crore LOU liability due on February 9. FIR filed against these companies with CBI
12: Total fraud of Rs 11,394 crore detected involving Modi group firms, Gitanjali group firms and Chandri Paper and Allied Products Pvt Ltd dating to 2011
13: Bank files fresh FIR with CBI and registers complaint with Enforcement Directorate
14: Bank informs the stock exchanges of the magnitude of the fraud
15: ED conducts raids across 17 locations; attaches properties worth Rs 5,100 crore
16: MEA suspends Modi and Choksi’s passport; CBI seeks Interpol help amid reports in several media outlets that the billionaire jeweller is in New York
17: The CBI arrests a former employee of PNB who is believed to be a key figure in the fraud disclosed by the country’s second-largest state-run lender earlier this week. Two other persons are also arrested, including a key employee of Modi.

Read | How Punjab National Bank fell victim to India’s biggest bank fraud

In the PNB fraud case, the bank employees had sent these guarantees in the absence of credit limits and collateral security (in Modi’s case). Secondly, they didn’t make an entry in the bank’s core banking system – the software used to support a bank’s most common transactions, which also acts as a record keeper. In some cases, they made a corresponding entry in the core banking system, but for lower amounts.

Why would an importer use this convoluted method to raise money?

There are multiple reasons. For one, he has raised money in foreign currency to pay for goods bought abroad. Second, the cost of such foreign currency borrowings abroad is typically lower.

What happens when the foreign bank or branch receives this guarantee?

When the foreign bank or branch receives the guarantee, for example from PNB, it will give a loan to the importer. That means it will deposit money either in the account of the supplier who’s selling goods to the importer, or in PNB’s account held with it. The tenure of this loan varies from ninety days up to even five years for capital goods. The money gets used to settle the payment for imports. Then, when the term of the loan is up and the importer makes money from reselling the goods he imported, he will pay this sum to PNB with interest. PNB in turn will settle with the.

What happened in this case?

According to the CBI FIR, in many transactions, the money raised through this guarantees was not used to make payments for imports. But it was used to settle earlier loans taken. In effect, every time a Nirav Modi related firm asked for a bank guarantee it was to settle an older loan taken through a previous bank guarantee. Thus, the amounts piled up to around Rs 11,400 crore.

How was this detected?

According to the FIR, two junior employees of PNB had been sending these unauthorised guarantees for seven years. Then one of them retired. In January, when representatives of Modi firms asked for a fresh guarantee, the new PNB employee in that position asked for collateral security. On being told that this was never asked for in the past, the bank started investigating and found hundreds of guarantees relating to these firms.

You mean no one thought to check this earlier?

PNB’s defense is that the SWIFT messaging system used to send these guarantees was not linked to its core banking system. SWIFT stands for the Society for Worldwide Interbank Financial Telecommunication. Experts also said that a concurrent audit — an audit of transactions done as they happen by internal or external auditors — should have caught this. Won’t someone look at the money deposited in PNB’s overseas accounts? Won’t someone reconcile SWIFT messages with the money that was transmitted through PNB’s systems? The jury is out on how many people at different executive levels are involved — either directly or because of negligence.

What happens now for PNB?

PNB is left holding bank guarantees worth Rs 11,400 crore which it has to pay to, among others, State Bank of India, Allahabad Bank and Union Bank. These payments are due over the next few months. The bank has tried to shift some of the blame to these banks. In a caution notice to the chiefs of other banks it essentially said this: You should have done more due diligence before giving out loans. Didn’t you notice that these guarantees are for one year, much above the RBI allowance of 90 days for the diamond industry?

Other banks aren’t buying these arguments. They say: We took an exposure on PNB, a state-owned bank (and an implicit bet on the Indian Union) not on a diamond merchant. It is still a gray area on who will actually pay up and how the burden will shared.

So, the banking system will take another Rs 11,400 crore on top of its huge bad loans problem of Rs 10 trillion?

Not necessarily. There will be some recoveries. For instance, the enforcement directorate has claimed it has already recovered gold, precious stones and diamonds worth around Rs 5,500 crore (although that valuation is debatable for an asset like diamonds). In any case, the entire Rs 11,400 crore which was raise for loans would either be in the form of diamonds (in case of genuine imports) or stashed away somewhere in other assets (if it had been diverted). It remains to be seen how much can be recovered.

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