PNB scam: Could be bigger than it appears

In New Delhi's Radisson Hotel on September 14, 2013, a meeting of the Board of Directors of Allahabad Bank was held to decide about sanctioning Rs 550 crore as a loan to  Mehul Chinubhai Choksi of  Gitanjali Jems. The then director of the bank, who smelt a rat in the whole process, tried to raise an alarm, screamed, knocked at the doors of many officials, but of no avail. Subsequently, he was made to resign.

The seeds of one of the biggest banking scams in India's history “ the Punjab National Bank (PNB) loan fraud of Rs 11,400 “ were sown then. The current face of the scam “ the multi-millionaire Nirav Modi “ joined only later. But in no time, he honed his skills in diamond jewellery trade and many other things, connived with bank staff, who agreed to throw the rule books out of the window in order to help a promising businessman, who now appears to have the blessings of more than one political party. But we cannot say that for sure, unless it is proved in a court of law. What we can say for sure and also be alarmed about is that the PNB financial fraud may be much bigger than it appears at the moment. Also, the involvement of other banks in the scam could be much greater than what is now being projected.

Amid political blame game and PNB's own defence, the authorities are treading carefully because banking is also a business, which should be insulated from external shocks. And in case of public sector banks, it is an issue of faith of more than one billion Indians for whom it is the safest place to deposit their money. So, one can expect a gradual opening of a can of worms.

For now, the country only knows that two PNB employees were involved to benefit a few companies of a big businessman and his family, who have left the country for good. Whether a scam of this magnitude can happen only by a staffer or two at a bank branch is something which has been left to people's imagination. But, it all started around the same time when the Reserve Bank of India was busy tightening the rules for housing, export loans and those taken against fixed deposits.

Guidelines to Lenders

In 2011, the central  bank began issuing guidelines to the lenders to strengthen their regulatory mechanism and introduce technology to reduce human interface in the banking business, including that of credit. But none of the public sector banks except three“ State Bank of India, Bank of Baroda and Corporation Bank adhered to such guidelines. PNB began the process very late and is still in the midst of it, paying the price for the current scam.

Additionally, a CBI  First Information Report (FIR)  into the scam said that most of the Letters of Understandings (LoUs) by the bank were issued in 2017. In this, the names of many other banks have figured which had given credit to several such businesses in countries like Mauritius, Hong Kong, and Frankfurt (Germany) on the guarantees issued by PNB. LoUs are issued in the cases where import payments are involved. They guarantee payment liability by one bank to another on behalf of a client.

According to international principle of banking, LoUs of a bank have to be honoured by another. In the present case, the LoUs were issued to three companies belonging to Nirav Modi for availing buyers' credit from overseas branches of Indian banks.

Surprisingly, none of these companies enjoyed any fund or non-fund-based limit with the bank  branch, and were only maintaining current accounts. And, none of these transactions were routed through the Core Banking System (CBS), which ensures audit of accounts on frequent intervals. Since they were not routed through CBS, they were able to avoid any early detection of fraudulent activity. These LoUs  were instead sent on SWIFT system and PNB officials never matched the SWIFT messages with contingent liability on their books.

SWIFT is a messaging service within banks through which they communicate with one another in a secure manner. In case of multi-bank transactions, it is helpful in transmitting instructions to various banks. At the end of the day, these messages have to be reconciled with CBS.

In the coming days, PNB will have to answer how without any entry into the CBS, a few staffers were allowed to issue LoUs for six to seven years, and whether there was an internal audit at all of the bank's books in these years. A bank goes through four kinds of audit - balance sheet audit which is called a statutory audit, internal audit, concurrent audit of bank transaction and RBI inspection. The PNB will also have to answer in due course as to how despite all these, the entire fraud escaped the bank's attention for seven long years. Was there anyone protecting this network of fraud? Additionally, the other LoU norms were also violated almost every time. Instead of a 90-day period, they were issued for 360 days.

PMO in probe

Different departments of the government are probing all possible angles involved in the scam. The Prime Minister's Office has also pitched in the probe. The Directorate of Revenue Intelligence, Serious Fraud Investigation Office, Ministry of Corporate Affairs, Ministry of Finance, and even the Institute of Chartered Accountants are all focused primarily on PNB as of today.

The Enforcement Directorate has even claimed to have recovered nearly half of the amount (Rs 51,000 crore) involved in the fraud through raids on Nirav Modi's properties. Some media reports say that PNB is expediting the sale of its real estate properties in Delhi to fetch over Rs 5,000 crore, implying it would completely negate the impact of the financial fraud it is going through. But all these can at best be termed as corrective measures.

A close look at the slump in PNB's profits over the past four to five years and consequent capital support into the bank by the government suggest that many at the helm were aware of the deteriorating health of the patient in the ICU, and yet chose to be silent. PNB's net profit had almost halved in 2014-15, from a high of over Rs 4,500 crore in 2012-13, while the government capital support to the bank reached over Rs 5,000 crore in 2017-18, from merely Rs 500 crore in 2013-14, in the wake of rising NPAs of public sector banks, the government's main reform focus in the past two years had shifted to the banking sector.

Recently, the government also promised to infuse Rs 2.11 lakh crore into the state-owned lenders, so that they are able to maintain robust health. Giving such huge monetary support to any institution has a cost implication which is largely borne by the middle-class taxpayers. When Finance Minister Arun Jaitley was asked, why he could not give a much expected income tax relief to the salaried class, his reply was that they needed to undergo some sacrifice, if wished to avail world -class services in infrastructure. A back of the envelop calculation suggests that if scams are reduced by half, even without paying so much taxes, Indians could avail world class services.