When it rains, it pours. Already embattled with a mounting pile of toxic loans, the Indian banking domain finds itself in a new spot of trouble — one that it won’t be able to sweep under the carpet. The freshly unearthed Rs 11,000 crore fraud perpetrated on Punjab National Bank looks all set to grace management textbooks years from now, helping soon-to-be MBAs decode the many failures of not just Indian banks but also of the banking regulator.

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For PNB, this is no less than a disaster. The fraud accounts for over one-third market capitalisation of the bank, which stands at Rs 31,132 crore. In fact, if one considers PNB’s free float market capitalisation, 95.8 per cent of PNB’s market cap is wiped out by this fraud alone. Underpinning this fraud is the all too ubiquitous tool of Letter of Undertakings (LoU). LoUs are assurances given by one bank to another mandating that the issuing bank will meet liabilities that arise on behalf of their clients. LoUs are arrived upon between Indian and overseas banks via the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network.

In this case, the bank has alleged that two of its rogue employees issued LOUs to overseas bank branches of a few Indian banks — including Axis and Allahabad Bank — on behalf of Nirav Modi’s companies. These LoUs were issued without entering it into the bank’s software system. This helped the fraud thrive undetected from 2010 until the time that the banking employee who was refreshing the LoUs retired.

However, this sorry affair is far from a simple case of two employees hoodwinking PNB in collusion with Nirav Modi. PNB has alleged that there is a case of ‘clear criminal connivance’ that can be made out between its two rogue employees, executives of Nirav Modi’s company and officials of other overseas banks. The bank is contending that the overseas branches had accepted the LoUs in favour of Nirav Modi’s companies for one year, which is in violation of the RBI guidelines that state that LoUs, once opened, will remain valid only for 90 days.

PNB is also alleging that some of the banks involved have not shared important documents relating to the credit purportedly given by PNB, which is to say, that PNB is accusing other banks of being in the know of the fraud. It is moot if PNB will actually follow up on the directions of the RBI to turn over and fork out the money to the Indian banks, on the other side of the transaction. RBI has said that if PNB does not pay the money to other banks, it could engineer “turmoil in financial markets” and erode the trust that is integral to working of banks.

However, given the parlous position of PNB, its board of directors and shareholders will be in no mood to accept the direction of the RBI, and will most likely knock on the doors of higher courts. Meanwhile, the banking regulator will have its hands full in curbing the contagion from this malfeasance. Even as a political storm billows, the man at the centre of the crisis, a la Vijay Mallya, has absconded.