The making of PNB Scam: Borrower-lender nexus exposes systemic flaws

Punjab National Bank's (PNB) letter to the stock exchanges on Wednesday has confounded the nation, where the Bank announced that it is facing one of the biggest frauds in the history of corporate India, at Brady House branch in Mumbai, where Rs 11,400 crore worth guarantee papers, known as LoUs (Letter of Undertakings), have been misused by a "select few account holders with their apparent connivance". These have been encashed in foreign branches of India's different banks.

Fear is deepening that the PNB default could trigger chaos across markets because the fraud amount adds to more than 1,200 per cent to bad loans in its non-fund estimation. LoUs come under non-fund loan. And, PNB' Basel III disclosure on December 31, 2017, had mentioned that its non-fund loan amount in gems and jewellery sector amounted to only Rs 842 crore.

Diamond merchant Nirav Modi and his partner Mehul Choksi had taken these loans on the guarantee of PNB's LoUs. Bankers who have lend to Modi and Choksi have started counting their exposure and very soon they may bill it to PNB. Above advances have been disbursed through Nostro account, in Hong Kong, by Axis bank and Allahabad Bank to the big jewellery companies of India. A Nostro account is an account that a bank holds with a foreign bank, usually in the currency of that country.

PNB shares had plunged 10.4 per cent on Wednesday. Its value eroded by about 24 per cent from $7.6 billion to $5.5 billion.

Initially, PNB had lodged a complaint with CBI for a Rs 280 crore fraud. However, after internal investigation, the alleged fraud amount jumped to more than Rs 11,000 crore. Government officials have warned that the amount and numbers of banks involved in the case may increase. "This fraud amount could reach more than Rs 20,000 crore as record of other banks are under scrutiny," a close source of Ministry of Corporate Affairs said to DNA, on condition of anonymity.

"10 officials of Punjab National Bank have been suspended in PNB fraud case, including the deputy manager of the branch," Rajiv Kumar, Secretary, Department of Financial Services (DFS) said.

What actually happened?

The Letter of Undertakings (LoUs) is a sort of guarantee given on behalf of the client to another bank. The alleged fraud has been done through LoUs, issued to a bunch of alleged fraudsters, especially related to the jewellery business, without any entry into the Bank's system.

On January 16, 2018, representatives of Nirav Modi-linked Diamond R US, Solar Exports and Stellar Diamonds approached PNB's Brady House branch and presented import documents and asked for buyer's credits for making payment to overseas supplier in Hong Kong. There was no sanction limit against all these firms. Hence, the newly-appointed deputy manager asked them to submit at least hundred percent cash margin to get LoUs as per rule. The alleged fraudsters claimed that they have been availing such facilities in the past without any securities. But the banker refused to give LoUs this time.

The Bank started the investigation and found that two of its officials — Gokulnath Shetty and Manoj Hanument Kharat — have facilitated such LoUs in the past. Shetty retired in May 2017 after serving in the same branch since the past eight years. He, with the help of Kharat, had fraudulently allowed such credit, without any documentation. They made SWIFT messages to foreign branches of Indian banks for raising buyer's credits. These funds were raised for the payment of import bills, but were not used for that.

What is an LoU?

The LoU (letter of Undertaking) is a kind of bank guarantee issued by banks for non-fund based loan. Banks provide two kinds of loans: fund-based limits and non-fund-based limit. Fund based means where banks directly give the money to the borrower. But in non-fund, banks provide only a guarantee paper. If a borrower defaults, then the bank, which has issued the LoU, has to bear the liability as a guarantor. In this scam, Nirav Modi and his team have taken the loan from foreign branches of Indian banks on behalf of LoUs issued by PNB.

WHO IS NIRAV MODI?

‘Diamond King’ Nirav Modi, listed among the Forbes’ 100 richest Indian, is an alleged kingpin of India’s biggest banking fraud. Modi is the founder of an eponymous high jewellery brand, which opened eight years ago. Now, it has expanded to the world’s most expensive retail locations, including boutiques in New York, Hong Kong, Beijing, London, Macau and Singapore. Modi was introduced into the diamond business by his uncle Mehul Choksi, the owner of Gitanjali Group, which has nearly 4,000 jewellery outlets across India.

WILL NOT SPARE ANYONE INVOLVED, SAYS PNB MD & CEO

Punjab National Bank (PNB) Managing Director and Chief Executive Officer (CEO) Sunil Mehta said: “We will not spare anyone who has been involved.” A day after the high-level fraudulent case came to the fore, Mehta alleged Modi had come up with ‘vague offers’ to repay the due amount without any clear plan. The PNB boss assured, “We will come out of the present situation. We are in discussions with stakeholders, including other banks that are party to this development. We will resolve it and honour all bona-fide commitments with other banks.” He further added: “We are known for clean banking. The fraud started in 2011. We have brought it under the notice of regulatory and law enforcement agencies as soon as we came to know about it. We will not spare anyone involved in the fraudulent practice,” the PNB MD and CEO assured. “We will not shirk our responsibilities,” he added.