Case study on Punjab National

Bank fraud 2018.

ETHICS AND CORPORATE
GOVERNANCE
PUNJAB NATIONAL BANK SCAM
 OVERVIEW:
•  A massive fraud of Rs. 11, 400 crore at Punjab National Bank by its
own officials has landed India's second largest bank in a huge
controversy. The PNB fraud came to limelight on February 14 after
the bank complained to the CBI that its own officials violated rules
and put out illegal guarantee documents to help celebrity jeweller
Nirav Modi secure credit from banks abroad. PNB is now making
attempts to recover the dues from the jeweller who fled the country
last month. Two central agencies - the Central Bureau of
Investigation (CBI) and the Enforcement Directorate (ED) - are
investigating the matter. Raids have also been conducted on Nirav
Modi's firms and jewellery, luxury cars, watches and other assets
have been seized; property, bank accounts associated with him have
also been attached.
 WHAT HAPPENED:
• India’s second-largest state-run lender disclosed that it has
been hit by the nation’s biggest ever bank fraud. 
Billionaire jeweller Nirav Modi and his associates colluded with
a rogue employee at Punjab National Bank to obtain fraudulent
guarantees worth $1.8 billion dollars over seven years. They
then used these documents to obtain loans from lenders
abroad. The country’s second-largest public sector bank (PSB)
said that two of its employees were involved in the scam,
where the bank’s core banking system was bypassed to raise
payment notes to overseas branches of other Indian banks,
including Allahabad Bank, Axis Bank, and Union Bank of India,
using the international financial communication system, SWIFT.
• The two of the accused bank officials gave the
fake Letter of Understanding and they haven't
mentioned any of the details to the book of
account of the bank and this thing was going
on from 2011.
• The bank haven't issued only one but near
about 145 Letter of Understanding and these
all amounts to 11 thousand crore.
 LoU the key to the fraud
• The latest fraud uses an age-old method employed to
defraud the banking system. It involved LoUs raised at the
PNB’s Mumbai office by firms owned by Modi and his family.
A LoU is issued by a bank to an importer (in this case Modi).
It works like a bank guarantee, which the importer can sell to
other banks at a discount. The importer receives the money,
or letter of credit, and pays his client. The issuer bank
messages overseas branches of other banks through the
SWIFT network, and that bank immediately pays the client
against the LoU. The bank that holds the LoU then goes back
to the issuer bank (PNB in this case) and gets its due.
• The issuer bank (PNB) recovers its due against the
LoU from its client (Modi). Since the LoUs are used
for importing goods and involve foreign currency, a
vostro account (client’s overseas account) is used to
deposit the credit by the bank accepting the LoU.
However, issuance of the LoU involves a lot of
process and to mitigate the risks of fraud, banks
insist the client deposit an equivalent amount of
assets, mainly cash, in the local branch, to avail of
the overseas facility.
• Nirav Modi, via his three firms, Diamond R Us, Solar Exports
and Stellar Diamonds, managed to pay to its suppliers of
rough stones on a regular basis. The payment was made
through the loans by banks including Axis Bank, UCO Bank
(Rs. 2,636 crore) and Allahabad Bank (around Rs. 2,000
crore). The loans were raised by Nirav Modi's firms on
showing the letters of undertakings issued by the PNB.
• Incidentally, there was no official record of such letters of
undertaking in the PNB records as the bank discovered early
this year before reporting the matter to the CBI.
 HOW DID IT COME INTO
LIMELIGHT ?
It came to light last month, when representatives of Modi’s
companies approached PNB for a fresh loan, the details of
which have been made public. By then, Shetty had retired
and his successor declined to honor Modi’s request. At this,
the firms contested that they have been availing this facility
in the past also but the branch records did not reveal
details of any such facility. This was when it discovered the
fake letters of undertaking and filed an initial complaint
alleging a $44 million fraud. Two weeks later, it filed
another complaint covering transactions worth about
$1.77 billion, according to people familiar with the matter.
 Is this the first time?
• SWIFT has been used by many people on a
number of occasions. In 2016, there was a cyber-
heist of $81 million from Bangladesh’s central
bank. Russia’s central bank recently reported that
$6 million was stolen from a Russian bank last year
by exploiting the SWIFT system. Even the Reserve
Bank of India stated that it had privately warned
Indian banks about the prospect of misuse of
SWIFT at least three times since August 2016.
 Why did it happen?
• PNB’s internal information systems were not
seamlessly linked to SWIFT. It is claimed that the
huge fund transfers made via SWIFT to Mr. Modi’s
companies by a few PNB employees went
undetected for many years. Many critics, contend
that the fraud is not simply a matter of the failure of
PNB’s internal control system. Instead, they blame
flaws in the ownership of public sector banks. In
fact, the PNB scam came to light only after a
whistle-blower exposed it.
• Following Bangladesh Bank heist in 2016 of USD 81 million, Reserve
Bank of India (RBI) had issued an advisory to all the banks asking
them to ensure that their computer systems running core banking
solutions (CBS) were properly integrated, wherever required, with
SWIFT (Society for Worldwide Interbank) - a messaging service for
interbank transactions across the globe.
• Now, PNB has said that due to system upgrade process, its CBS was
not integrated with SWIFT for several years. Some experts have
estimated that had the PNB taken the RBI advisory seriously and
detected the fraud even a year early, it could have kept the loss to
bank limited to USD 800 million.The current estimate is that the
PNB fraud cased a loss of USD 1.8 billion or Rs 11,400 crore. 
CAN FUTURE BANK FRAUDS BE PREVENTED?

• There is an RBI advisory on almost all kinds of possible bank

frauds. Yet, banks and customers are routinely cheated but to
cause a fraud of one that is still unravelling at the PNB requires
bigger networking of conniving individuals who play around the
rules and banking systems.
• RBI has constituted an expert panel to examine what is ailing
banking operations resulting in increasing cases of big frauds. The
panel has been tasked to recommend measures to fix the
systemic loopholes. The Centre is also analysing the risk
management framework for banking sector.
• However, with the existing rules and laid down procedures most
of banking frauds can be prevented.
 What banks may do in future?
• All the banks should review their critical systems and processes including
the IT segment regularly. Ethical banking practices should be preferred.
Disclosures to RBI, SEBI and other regulators should be made with
consistent periodicity.
• Banks should ensure that there are adequate systems and controls in place
to identify potential risks and that they are being followed at all relevant
branches. SWIFT-CBS linking must be made mandatory for all LoUs.
Confirmation from lending foreign branches must be done for each of the
LoUs.
• All internal and external audits must be completed on time at branch level.
The audit reports should be shared with the government's auditors and
examined by the RBI, which should conduct a separate audit every year. In
the PNB fraud case, the bank has told the finance ministry that the last
audit by RBI was done in March 2009.
 Steps taken by the Government:
• The Union government signalled a zero-tolerance approach to
white-collar crime, approving a new law targeting economic
offenders fleeing the country, and creating a regulator for
chartered accountants and audit firms.
• The actions, came two weeks after Punjab National Bank (PNB)
went public with a multi-billion dollar fraud, are part of a series
of steps the government has initiated to mitigate the financial
and political fallout of the scam.
• These include banking and bankruptcy reforms, disqualification
of directors of errant companies, striking shell companies off the
records and stringent action taken by various regulators in the
last few weeks against those who allegedly duped banks.
• The Fugitive Economic Offenders Bill 2018, which will be
tabled when the budget session of Parliament resumes,
provides for proclaiming an economic offender who has fled
the country as a fugitive, issuing an arrest warrant against the
person and confiscating his or her assets before conviction.
• Finance minister Arun Jaitley said that the bill provides for
confiscating all assets of such offenders including
any benami assets, not just the proceeds of crime.
• Only offences above Rs100 crore will be pursued under the
Fugitive Economic Offenders Bill 2018 in order to prevent
overcrowding of courts.
Thank You.