India’s PNB discloses a billion-dollar scam

• Punjab National Bank revealed that it has detected a $1.7 billion (INR11,000 crore) fraud
• The Reserve Bank of India has already disclosed in its June 2017 Financial Stability Report that the volumes of frauds and bad loans in the country were increasing
• Bank officials and regulators should work more responsibly to prevent another fraud scam in the future

February 14, Punjab National Bank (PNB) disclosed that a $1.7 billion (INR11,000 crore) fraud was allegedly committed by Indian jeweller Nirav Modi and his uncle Mehul Choksi with the help of ex-PNB employee Gokulnath Shetty, since 2011. In the aftermath of this huge scandal, one PNB branch closure, six bank official arrests, millions of frustrated customers, and billions of unaccounted money were reported. Many analysts believe that the lack of regulatory oversight and proactive response as well as mismanagement resulted in this scam.

It was revealed that that the Reserve Bank of India (RBI) did not conduct annual audits on PNB’s Brady House branch – the one involved in the scam – despite the fact that it was located in a premier business district and have been regularly dealing with high-net-worth individuals. The last audit on the branch was held nine years ago in March 2009. This however does not mean that RBI had no knowledge of the problem. In fact, in its June 2017 Financial Stability Report, the regulator mentioned that the volumes of frauds and bad loans were increasing. S.S. Mundra, the former deputy governor, also spoke about misuse of the SWIFT infrastructure way back in 2016; and yet despite these warnings nobody seemed to have taken action to improve risk assessments, or even audit-check necessary banks.

The bank also knew that lending to jewellery-based businesses is historically prone to risks. In 2013, jeweller Winsome Diamond Group applied for loans from a consortium of banks including PNB. The lenders issued standby letters of credit to international bullion banks to supply the jewellers with gold, with the understanding that if the jewellers failed to pay for the purchase, the banks will be the one to shoulder it. This eventually became the case when the jeweller in question started to wilfully default on its loans, forcing PNB to pay the UAE gold bullion banks.

Five years later and the same incident happened with Nirav Modi as the main character when former PNB deputy manager Gokulnath Shetty issued letters of understanding (LOU), which promises that the bank shall pay for the loans if Modi fails to do so. This begs the question why PNB let the same problem happen again? Furthermore, the bank hasn’t upgraded its software, still using the outdated 2001 version of Infosys’ Finacle despite the availability of a 2008 upgrade that could have integrated SWIFT’s interbank messaging software with PNB’s core banking system. This could have prevented Shetty from issuing the LOU without it appearing on PNB’s record. It was also noted that the same reference number was used for all of Modi’s transactions. And these multiple transactions smoothly proceeded at a branch level without catching the attention of top executives.

How can the public trust a bank that fails to safe keep their money, or regulators who were not able to raise a red flag when they notice something is going wrong? Bank officials and government watchdogs are expected to work more responsibly to prevent another fraud scam in the future.