PNB's storm of fraudulence
Punjab National Bank (PNB) informed the Bombay Stock Exchange (BSE) on Wednesday that it has been hit by a banking fraud to the tune of Rs 11,300 crore. The bank has also lodged a complaint with the Central Bureau of Investigation (CBI) and the Enforcement Directorate (ED), naming billionaire diamond merchant Nirav Modi, his wife Ami Modi, his brother Nishal Modi and his maternal uncle Mehul Choksi, managing director of Gitanjali Gems, in a Rs 280 crore fraud. The frauds were committed through the letters of credit used in the export-import business.
A letter of credit is given by the importer to the exporter, who can show it to the bank as import orders and can ask the bank to provide a line of credit in foreign exchange for a period till the order is executed and the exporter receives their due payment. In the gems and jewellery business in India, the jewellers first import rough stones from various countries and after processing them, they resale the finished products or processed colour stones. In the case involving the Nirav Modi family, a line of credit was given to procure rough stones, which were to be processed and made into finished jewellery pieces before being sold again, mostly in the global markets. With the LC, Nirav Modi was able to convince his bank to provide a line of credit in foreign exchange (a guarantee to the other bank) to pay for its import of rough stones. Based on the line of credit, foreign banks offer a line of credit in the local currency.
Here, in this case, when foreign banks (overseas branches of Indian banks) approached PNB for the payment of the loaned amount to Nirav Modi, PNB told the banks that it was hit by a fraud as the Letters of Credit based on which the line of credit was offered were fraudulent and that some of the bank's staff were allegedly involved in the concerned fraud. Most of the rough stones and diamond procured are mined outside India but more than 90 per cent of it is processed and made into finished products within the country. The inventory is finally sold worldwide, China and the US being the two biggest markets.
After the sensational disclosure, PNB shares closed 10 per cent down on Wednesday. The fraud amount is eight times the bank's 2016-17 profits and one-third of its market capitalisation. The bank could not detect the frauds because the SWIFT system of financial messaging through which the transactions are made works independently of the Core Banking System (CBS). Some of the bank's staff used their access to SWIFT and assisted Nirav Modi in the alleged fraud. The bank has suspended around 10 of its personnel and named a couple of them in the complaint lodged with the CBI and the ED.
Indian banks have been notorious for refusing bank loans to small-scale businesses or small-time entrepreneurs. The guarantees and collaterals that they seek before handing out small loans are simply monumental and cumbersome, whereas big businesses and the rich have a relatively easy access to bank loans. At a time when Indian banks are struggling with huge amounts of non-performing assets, running into Rs 6.5 lakh crore as per one estimate, the latest fraud, once again, highlights how easily big businesses and their promoters can bend and manipulate the banking system to seek the desired benefit from it, lawfully or otherwise.
PNB has made it clear that it will not honour the fraudulent bank guarantees. PNB's disclosure may be followed by similar unnoticed frauds at other banks as nearly all banks offer credit guarantees based on letters of credits. The full scale of the frauds will be clear only after some weeks when other banks complete their audit and see if they too have been duped by fraudulent businessmen.
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