PNB Scam - Law Insider Insight
The PNB scam refers to the fraudulent letter of undertaking worth over Rs 10,000 crore issued by the Punjab National Bank at its Brady House branch in Fort, Mumbai.
On 29 January, 2018, the Central Bureau of Investigation filed a criminal complaint against three companies and four people, including billionaire jeweller Nirav Modi, his brother Neeshal and uncle Mehul Choksi, the managing director of Gitanjali Gems Ltd, saying they had defrauded the bank initially reporting a loss of Rs 280 crores, later realised to be Rs 14,000 crores.
All three were partners of M/s Diamond R US, M/s Solar Exports and M/s Stellar Diamonds. Nirav Modi and his family absconded in early 2018, days before news of the scam broke out.
The bank in its complaint alleged that the accused were in collusion with two other junior employees at the said branch causing them a wrongful loss.
Obviously, this being the huge amount, the PNB scam is said to be the biggest in India’s banking history. How does one get away with a fraud of such a magnitude?
Initial Unfolding of the Scam
PNB alleged that the associates of the accused firm on 16 January, 2018, presented a set import documents asking for buyers’ credit. Nirav Modi being an importer of diamonds, importers prefer to take loans in foreign currencies as they have lower interest rates.
Buyers credit is a loan taken from an overseas bank the payment of which was going to be guaranteed by PNB. In order to do this, PNB had to issue a letter of undertaking or LoU to the overseas bank which again guarantees the payment of the loan issued to the client at the home bank.
The assurance is directly between the home and the overseas bank, in what is known as a nostro account and not the client, in this case Nirav Modi.
The bank alleges that the loans issued against these LoUs may not have been used for imports but perhaps some other purpose. One way could be that multiple LoUs were issued over the years, or LoU issued were simply extended.
As part of its due diligence, PNB should have verified Nirav Modi’s credit-worthiness or asked to present collateral greater than the loan amount, but the bank did neither as the firms argued that they had used such facilities in the past without keeping any money on margin.
PNB then started to search its records, the bank found no trace of such transactions and thus it began suspecting fraud.
PNB ignoring red flags
The LoUs are delivered through SWIFT, that are coded messages used in international banking. It was found that two junior employees of PNB had issued LoUs on the SWIFT interbank messaging system without entering the transactions on the bank’s own system.
Such transactions went on for years without detection. In India, all banking records are saved on the core banking system, and CBS and SWIFT transactions are recorded on one interface but PNB did not have this mechanism, yet it did not manually record to ensure they were in sync and thus messages were sent out without matching entries in CBS.
As mentioned above, PNB said that the employees colluded with the accused firm adding that some staff of the foreign branches of the other Indian banks might be involved too, including Allahabad Bank, Axis Bank, etc.
Is PNB completely oblivious?
SWIFT accounts go through a three-step verification- create, check and authorise the transactions. Thus, bank employees at different levels were probably complicit or either completely negligent.
Again, it is unlikely to believe that the top management at PNB was unaware that huge multi-crore loans were being guaranteed without any collateral.
As per the RBI guidelines, buyer’s credit for import of gems should not exceed 90 days from date of shipment. However, in the case they were rolled over repeatedly. Also, the bank’s auditors were clearly complicit and negligent as well.
Aftermath of the scam
Nirav Modi who absconded early 2018, was found in London, where he was seeking asylum and in March 2019 was arrested and is currently facing extradition to India, where he is going to face charges of fraud and money laundering.
He was declared a Fugitive Economic Offender under the 2018 act of the same name. He is the second person to be declared a FEO after Vijay Mallya.
A special court of the Prevention of Money Laundering Act also allowed the confiscation of assets owned by him, worth over Rs 1400 crores. Nirav Modi is also on Interpol’s wanted list.
As far as reforms are concerned, Reserve Bank of India today decided to discontinue issuance of letters of undertaking (LoU) and letters of comfort (LoC) for trade credit for imports into India.
The Fugitive Economic Offenders act was introduced to deter economic offenders from evading the process of law by giving powers to the government to confiscate properties of absconding defaulters.
Originally published at https://lawinsider.in on September 21, 2020.