The ugly truth of the Rs 11,400-crore Punjab National Bank (PNB) scam at its Brady House branch in Mumbai makes a mockery of our banking system. The scam is claimed to have gone undetected for seven long years by the superior authorised signatories of the branch and through all the internal, external and statutory audits, the top management of PNB and the RBI's inspection teams. It shows up a total collapse of systems, controls, procedures and oversight.
What happened and how
A few unscrupulous staff of PNB's Brady House branch are said to have issued some 150 fake Letters of Undertaking (LoUs) in favour of Nirav Modi's companies to allow the diamantaire to obtain short-term loans in foreign currency from overseas branches of Indian banks (Allahabad Bank, Axis Bank, SBI, etc).
The need for an LoU arises when someone importing goods needs to make payments to foreign suppliers. By issuing an LoU in favour of Modi, PNB guaranteed to the other banks that it would pay them back the monies they loaned to Modi. But for that, Modi would have to first repay the loan to PNB, which he did not. Instead, the bank kept giving him one LoU after another to pay for the previous LoUs. Eventually, it became a Rs 11,400 crore mountain of debt.
Shockingly, the LoUs were issued without any collateral, insistence on margin money or third-party guarantee. Moreover, the staff issued the LoUs using the SWIFT wire-transfer key (Society for Worldwide Interbank Financial Telecommunications) without routing and registering the transactions through PNB's Core Banking System (CBS).
That's the bank's story. But a scam of this magnitude â€“ and we haven't still seen the end of it at Rs 11,400 crore -- cannot be committed by just a few managerial level staff and go undetected for seven long years. The PNB top management, its Board, its statutory and internal auditors, and the RBI and the government are responsible and accountable for it in varying degrees.
The anatomy of the fraud raises many questions:
n Why did PNB not follow the system of rotation of jobs, especially in the critical domain of overseas funding, EXIM (export-import) transactions and treasury management? Normally, rotation of jobs or transfers happen once in three years. But Gokulnath Shetty, the retired deputy manager accused of being Modi's inside man issuing the LoUs fraudulently, was in that seat for over seven years. It was only after he retired that the scam came to light. The mass transfer of 1,400 staff of PNB in the last few days, after the great loot, is of minor consequence.
n Let us agree for a minute that just two bank staffers managed to operate the SWIFT switch to issue the LoUs fraudulently and no one else was involved. Could it have gone unnoticed for seven years? It could have gone on only for a short period. Since PNB charged a commission for issuing the LoUs, the entire transaction would have had to be accounted for as soon as the bank obtained its commission, since the loan money comes into a PNB "nostro" account and would be settled through it.
All these transactions are bound to have "contra entries" â€“ to be tallied and reconciled. For the bank not to have noticed the LoUs, the successive heads of PNB's Brady House branch would have had to suffer from "selective ignorance". One of them, who had gone on to become a general manager, has been arrested by the CBI.
n The internal or statutory auditors appointed by PNB, with the "express approval" from its Board, failed to detect the unscrupulous practices, suspicious transactions, non-adherence to standard operating procedures, let alone unearthing the fraud. Can you imagine that, given that auditors routinely harass bankers for simple non-compliances such as not obtaining KYC documents from customers?!
n The top management of PNB failed in periodically reviewing accounts of high net-worth individuals (HNIs), generation of fresh credit (CIBIL) reports, review of Special Mention Accounts (SMA), restructuring of non-performing assets (NPA) and continuous 'evergreening' of stressed assets and Letter of Credit (LC) limits. The most glaring discrepancies in the transactions have not been picked up. The dereliction of duties and the systemic collapse is evident.
n The Reserve Bank of India, the banking regulator, also failed. The RBI deputes its inspecting teams periodically to all public sector banks (PSB). How did the RBI inspectors fail to detect the fraud at Brady House branch?
n The RBI keeps an eagle eye on transactions involving foreign exchange. The fake LoU transactions are all associated with huge forex implications and possible money laundering. The RBI will have a tough time explaining how it failed so miserably on this sensitive issue.
n In September 2016, former RBI Deputy Governor SS Mundra had highlighted the increase in "fraudulent messages" through SWIFT, non-adherence to the 4-eyes principle, and not routing SWIFT transactions through the CBS. Why didn't the RBI follow it up with punitive/corrective action?
n How did RBI allow 0% margin LoUs? RBI may now bring PNB itself under the Prompt Corrective Action (PCA) on account of the grave issues that the bank will face from now on â€“ frauds, huge NPAs/stressed assets, a possible "run on the bank" for deposit withdrawals, erosion of PNB share value in the stock market and loss of credibility.
n The role of the nominee directors of RBI, the Government of India and part-time non-official directors under CA category on the Board of PNB will also come under the scanner as their expertise and "reservoir of knowledge" seems to have been restricted to just attending board meetings only for the sake of fringe benefits.
The Banks Board had a special responsibility to design the risk management architecture and ensuring the same with periodic reviews of the assessment of inspections/audits and to recommend preventive/corrective steps. Did it perform its duty?
n The government has failed to ensure proper governance of the PSBs. Given the manner in which private sector banks are functioning â€“ professionally, profitably and with good returns to stakeholders -- it is time the government weighed privatising a few big PSBs.
The opportunity presented by the Rs 11,400 crore scam to reform the banking system should not be lost. The government should submit a white paper on the PNB fraud, detail actions that will be taken, and appoint an expert committee to look into all possible lacunae in the banking system and make far-reaching recommendations to overhaul it.
(The writer is a Bengaluru-based banker)