“Punjab National Bank (PNB) detected alleged fraud (PNB Scam) of Rs 11,500 crore at its Mumbai branch on Wednesday. The alleged fraudulent transactions were reported to benefit a few account holders in apparent connivance of the some of the bank employees. Letters of Undertakings (LoUs) were fraudulently issued by two of the bank employees and instructions by Society for Worldwide Interbank Financial Telecommunication (SWIFT) was transmitted to the overseas branches of the other Indian banks to raise buyers’ credit for companies of diamond jeweller Nirav Modi without making an entry in the account books, PNB informed Bombay Stock Exchange (BSE). The alleged fraud amount of Rs 11,500 is more than double of Rs 5,473 crore, the amount promised by the government under bank recapitalization plan last year.”
These type of headlines were there in almost all main newspapers of India, on the occasion of valentine day. What was the fraud? What is this LOU, SWIFT, and Buyers’ credit? And who is Nirav Modi? Read further to get the answers, and to understand the modus operandi of the fraud.
Nirav Modi is one of the richest Indians, a jewel businessman. He has opened stores on the prime locations such as the Old Bond Street in London, Hong Kong, and Macau. Nirav Modi store in New York shares space with legendary brands such as Chanel, Hermes, Prada, and Gucci. The brand ambassadors include some eminent personality such as Kangana Ranaut, Priyanka Chopra.
Let’s understand LOU first.
Letter of Undertaking is a bank guarantee and is issued for overseas import payments. A bank, while issuing LoUs for a client (here Nirav Modi), agrees to repay the principal and interest on the client’s loan unconditionally. When an LOU is issued, it involves an issuing bank, a receiving bank, an importer and a beneficiary entity overseas. According to norms, the term of an LOU is 180 day and can be rolled over once for six months. Since LoUs are a form of lending, they are typically backed by security.
It began with diamond firms of Nirav Modi ( Diamonds R US, Solar Exports, and Stellar Diamonds) approaching PNB for seeking LoU for import of rough stones. It is a promise that PNB gives to foreign lender saying that it’s a good borrower if it defaults we’ll pay you back.
Once they receive the LoU the foreign bank approves buyers’ credit. Buyer credit is a short-term credit available to an importer (buyer) from overseas lenders such as banks and other financial institution for goods they are importing, rough diamonds in this case. Buyer’s credit helps local importers gain access to cheaper foreign funds as against local sources of funding which are more costly.
Through the buyers’ credit amount gets credited to PNBs nostro account (an account that a bank holds in a foreign currency in another bank). The money doesn’t reach to any of these borrowers, it remains in nostro account and eventually gets paid to the supplier.
The fraud is that when they received these LoUs they didn’t have required documents or sanction of credit. The company did not have any sanction limit from the bank neither any kind of deposit or long-term relationship with the bank which is required to sanction LoU.
But then how did the LoUs get sanctioned?
An internal probe by the bank then found that a few of its employees had fraudulently issued LoUs for Hong Kong branches of two Indian banks for and on behalf of Modi’s firms.
In January, when a couple of LoUs matured but the banks did not receive their payments, they approached PNB for repayment of the loans. Also, one fraudulent LoU was issued on January 16, 2018, for and on behalf of Modi’s firms, which allegedly presented a set of import documents to the branch, with a request to allow buyers’ credit for making payments to suppliers overseas. When bank officials requested the firms to furnish 100% cash margin for the LoU, the firms argued that they had availed this facility in the past as well, without paying any cash margin.
However, branch records did not have the details of any such facility having been granted to the firms. Why?
This was because these transactions were never recorded in the PNB’s Core Banking Services (CBS) software (the finnacle software used by banks).
When an LoU is issued, the message of credit transfer is conveyed to overseas banks through the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system. This is a significant information as it gives the bank’s consent and guarantees. To issue SWIFT, an official has to log in and fill up confidential information such as the account number and SWIFT code. It generally has three layers of security – a maker, a checker and a verifier within the core banking system before it is issued.
The alleged bank employees, somehow, bypassed the CBS and transmitted the transaction through SWIFT. The transactions were initially routed through the CBS system but subsequently, changes were made in the LoUs by substantially increasing the amount and transmitted through SWIFT without reporting this to CBS.
According to PNB’s complaint to CBI, the LoUs were issued for the Hong Kong branches of Allahabad Bank and Axis Bank which have given money to the beneficiary entity on behalf of Modi’s firms. As a result, PNB will have to settle the LoUs with these branches according to the norms of the Hong Kong Monetary Authority.
The PNB is going to suffer from a very big loss, both in monetary and non-monetary terms. The market sentiments are already down. The PNB stock fell 9.81% on Wednesday to close at Rs 145.80 per share, and investors lost over Rs 3,000 crore in a single day.
The bank may have to set aside higher provisioning in the next few quarters if it unable to recover the money from the accused firms. Also, RBI has ordered the bank to pay for the deeds committed by its employees; to settle the transactions with other banks whose loans are maturing.
