India’s Punjab National Bank Scandal Causes Uproar

On the morning of February 16, India’s second-largest state-run bank, Punjab National Bank, quietly announced to stock exchange authorities in Mumbai, that it has been defrauded of $1.8 billion.

But things did not stay quiet. Within minutes, panic had broken out in India’s financial markets. Indices tanked, especially bank share prices, as fears grew that the financial scandal was widespread, Al Jazeera reported.

The news was widely reported by global media, not surprising, for this was no ordinary fraud: this was the biggest bank fraud of its kind in Asia’s third-largest economy.

It took five days for Arun Jaitley, the finance minister, to break his silence. On February 20, he sought to hold the bank’s managers and its auditors responsible for the fraud, at the center of which is Nirav Modi, a high-profile diamond merchant, his uncle Mehul Choksi and their associates. (Nirav Modi shares the same surname as India’s Prime Minister Narendra Modi but is not related to him).

Before the finance minister spoke, the position of the government and ruling Bharatiya Janata Party on the scandal had, oddly enough, been announced by its top ministers, including Defense Minister Nirmala Sitharaman.

Speaking about PNB’s management and auditors at an event in New Delhi, Jaitley said: “…on the face of it, the answer seems, yes they (the bank’s managers) were. They were also found lacking in being able to check who amongst them, were the delinquents here…What are our auditors doing? Both internal and external auditors really have looked the other way or failed to detect (the fraud).”

The fraud, which occurred in one branch of PNB in central Mumbai, was apparently a misuse of letters of undertaking and the SWIFT international messaging system between banks, resulting in a subversion of checks and balances that are supposed to be an inherent aspect of standard banking practices.

  Ledger Entries Fudged

An LoU is a kind of a bank guarantee enabling one bank in India to raise funds from the same bank or another bank’s foreign branch in the form of short-term credit in order to use it for payments to offshore suppliers or trading entities.

SWIFT is an acronym for Society for Worldwide Interbank Financial Telecommunication. It provides a network that enables financial institutions across the world to send and receive information about transactions in a standardized and secure manner.

To raise an LoU, the customer (importer) is supposed to pay a sum of “margin money” to the bank issuing the LoU and, based on that, they are granted a credit limit. But in Nirav Modi’s case, there was no credit limit, nor did he ever pay any margin money.

Once the letter of credit is accepted, the lender or the foreign branch of the Indian bank, in this case, PNB, is supposed to transfer money to the Nostro account of the bank that has issued the LoU. (A Nostro account is one held in another bank in a foreign country in order to hold foreign currency.)

What happened in this instance is that PNB and its affiliates extended credit to entities linked with Nirav Modi and Choksi that was far beyond stipulated norms, which is usually 90 days.

The evidence in the still-ongoing scandal suggests that there were incomplete or fudged ledger entries and “evergreening”, a term that means advancing fresh loans to repay old loans, which is usually illegal.

“There was a complete breakdown of checks and balances in the banking system,” Hemindra Hazari, a Mumbai-based independent analyst of India’s banking sector, told Al Jazeera.

  Debate Over Scandal

The scandal has sparked a big debate on the working of India’s banking sector, which was largely nationalized in the early-1970s. Currently, roughly 70% of banking assets in the country are in the public sector. Right-wing ideologues argue that the kind of fraud recently witnessed may not have taken place had banks been privately owned and controlled.

The counterview is that a number of frauds have occurred in private banks and that the problem is not one of the kinds of ownership, but one of lax systems of compliance that promote corrupt practices.

According to official estimates, the total quantum of bad loans in the country’s 38 listed commercial banks had exceeded Indian Rupees 800,000 crore at the end of June 2017 or the equivalent of over $125 billion—accounting for over a fifth of all loans given by banks. Even as the government has periodically infused taxpayers’ money to bail out banks, what has been particularly disconcerting is that the bulk of these unpaid loans have been disbursed to large corporate bodies and their promoters.

Many economists argue that this has exacerbated inequalities of income and wealth in a country that has already been sharply polarized between the rich and the underprivileged.

The PNB fraud has attracted considerable media attention because of the celebrity status of Nirav Modi, who is currently absconding outside India.

He has been featured on catalogues of Christie’s and Sotheby’s and finds place in the list of the country’s top billionaires compiled by Forbes, which has estimated his net worth at more than $1.7 billion.

India’s law-enforcing agencies have arrested officials of PNB and companies headed by Nirav Modi and Choksi. But the storm over the country’s biggest bank fraud will not subside in a hurry.