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Uncovering the PNB fraud: India’s latest banking scandal | Surya Suresh

On Wednesday, 14 February 2018, India’s banking sector was jolted by its latest scandal as Punjab National Bank, India’s second-largest bank reported a fraud amounting to Rs 11,000 crore.

The fraud is expected to have far-reaching impacts on the international operations of a consortium of Indian banks, including Axis Bank and Allahabad Bank. As expected, the stock market has reacted negatively to this development with PNB’s stock seeing a 17% fall and Nifty PSU Bank seeing a 5% fall.

How the PNB fraud unfolded

The key perpetrators of this fraud are the companies of Nirav Modi and Mehul Choksi, two of India’s wealthiest diamond barons. The fraud began with the issue of Letters of Credit by PNB for the import of diamond stones by the companies mentioned above. As per common practice, PNB then issued LoU’s or letters of undertaking with the foreign branches of other Indian banks (the counterparties), in order to receive funds for its NOSTRO account (the account an Indian bank has with a foreign bank).

Two conniving employees of PNB’s Mumbai branch issued fake LoU’s to the foreign branches of Axis Bank and Allahabad Bank. The fake LoU’s had substantially larger amounts compared to the terms agreed upon. The employees bypassed the Core Banking System (CBS) and used SWIFT as a payment method in order to avoid detection, thus keeping PNB in the dark for a long time.

In order to repay the foreign branches, the diamond barons would get fresh LoU’s issued by their accomplices at PNB, thus borrowing money from one bank to repay the loans of another. The cycle continued and the account of the diamond companies continued to accumulate credit owing to poor auditing by the banks.

The fraudulent transactions were finally discovered by PNB on 25 January 2018 and the bank immediately reported the fraud to the regulators and law enforcement agencies. It has since come to light that the fraud has been going on since 2010. Since the LoU is a guarantee of payment by PNB to the counterparties, the company is liable to pay the entire amount despite being the victim of the fraud.

Aftermath of the expose

The RBI has directed PNB to pay the entire amount owed to the counterparty banks and many bankers believe that this move was necessary to prevent turmoil in the banking sector. Reports suggest that many banks have met officials from the RBI in order to discuss the dues from PNB.

PNB has requested the government to intervene on its behalf as the bank is short of funds. PNB MD & CEO Sunil Mehta addressed the press on Thursday and was confident that the bank had the capability to recover from this blow. Moreover, he stated that PNB would take full responsibility if the CBI investigation placed the onus on them.

Meanwhile, India’s two major political parties have been bickering amongst themselves and playing the traditional blame game. The Congress has accused the BJP of conniving with Nirav Modi while the BJP has accused the former of being responsible for the entire mess of bad loans.

What does the future hold?

A quick glance through the recent scandals in the banking industry allows one to identify certain common reasons behind these incidents. Most of these scandals, including the PNB case, have resulted due to poor security systems, lack of common protocols and a lack of coordination between banks.

Blockchain technology, which has come to light owing to the success of cryptocurrencies could play a key role in solving all the aforementioned problems. The blockchain is seen by many banks as a cheap, secure and fast alternative to the SWIFT payment system. It provides a securely distributed ledger that would greatly streamline the processes involved in banking. So, could blockchain replace the existing payment methods?

While there has been a lot of hype around blockchain, it is important to realise that the technology is only at its nascent stage. A few companies like Ripple have developed prototypes for banking use cases but no company has been able to develop a revolutionary product. Further, it will take a while to align blockchain technology with international regulations for money transfer.

For now, it appears that banks will have to make use of existing tools to enhance security. Greater vigilance, regular audits and better coordination with other bankers is the way forward in the near future.

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