In what may be the largest scam of its type, the second largest government-owned bank by asset-value, the Punjab National Bank (PNB), is at the centre of a Rs.11,000 crore bank fraud case. The prime accused, as everyone knows by now, is billionaire jeweler, Nirav Modi.
First, on the actual case involving the bank itself.
PNB, earlier this month, informed India's stock exchanges of a Rs 280-crore fraud and later found fraudulent transactions dating back to 2011. The PNB's Brady House branch in Mumbai was the epicenter, where some employees issued letters of undertaking to Modi's companies, so that, they could raise money from international branches of other Indian banks as buyer's credit.
The extent of the fraud – Rs 11400 crore - has shaken the Indian banking system. The CEO of the bank, Sunil Mehta, said on Friday that they had begun investigations. On Saturday, the CBI arrested PNB's former deputy manager Gokulnath Shetty, the bank's single-window operator Manoj Kharat, and Hemant Bhat, authorized signatory for Nirav Modi's firms.
The investigation now starts to untangle the web. The key players in this case are the CBI and the ED. One remarkable aspect of this saga is that PNB won awards for excellence in banking vigilance over the past couple of years.
The bank has enough assets and will be able to cover for any associated losses, but the banking sector as a whole has also taken a hit and points to a larger problem of oversight and scrutiny as pointed out by The Hindu editorial –
"For India's second largest bank to be defrauded in the manner suggested is astounding, especially since there has been heightened scrutiny of public sector banks' operations in the last few years".
The bank's performance in the stock market since the scandal broke has been abysmal. The share price has dropped significantly since last week and its market capitalization has tanked. The modus operandi was to get loans without any guarantee with assistance from the bank employees.
"It appears that the bank employees who assisted in the fraud routed large transactions for the borrowers by circumventing the core banking solution. This flies in the face of the government's push for a digital payment economy".
"The banker-borrower nexus has been blamed for problems in the banking system for years. This episode will set off fears of a nexus deeper than imagined. The RBI and investigating agencies should act speedily to restore trust in the banking system".
The man at the centre of the scandal is Nirav Modi. A jeweler to the stars, he has been a regular on the front covers of leading international financial dailies and luxury fashion magazines. He had come under the scanner of the Directorate of Revenue Intelligence (DRI) in 2014 when they called him out for a violation of import-export rules on duty-free, cut and polished diamonds and pearls.
The problem here lies with the banking sector in general and PNB in particular. With regards to PNB, there is little doubt that this is failure at the higher levels in the bank and questions should be directed to the top management; particularly how few relatively low level employees were able to carry out these activities in one particular branch. Why was there no effective due diligence done on Modi and his firms? Though the CEO did offer assurances, it is imperative for them to implement changes in the light of the recent news.
Regarding the banking sector, this is where institutions such as the central government and the RBI come into the picture. In a column for the Free Press Journal, journalist Jagdish Rattanani and former central banker RK Pattnaik state the role of these particular institutions in this particular instance -
"At the level of the government, the finance ministry and the RBI, there is an urgent need to relook at the health of the regulatory environment. The RBI has reportedly said this was lack of internal controls at the bank".
"What the entire regulatory setup has failed to do is protect the people's money. In the end, the loss is being borne by the ordinary citizens of India, multiplied manifold, as we look to peoples funds being invested into stocks of these rogue companies".
The key point made here as stated in the column is that the reason the banking sector is regulated is that the industry works on depositors' money. The Hindustan Times editorial states that this case is the tip of the banking crisis iceberg –
"The inability to tackle bad loans more urgently has weakened banks to an extent that they have been unable to lend on the one hand while the government has had to use taxpayer money for a bailout on the other".
In cases like this involving banks that are primarily owned by the government, there are always assurances that they will provide capital to keep the bank afloat and the tab will be picked up by the taxpayer. The government has been infusing capital in banks to make them stronger since most have been struggling under bad loans.
"The recent activism of the RBI - be it in terms of goading banks to reveal the true extent of their soured loans or forcing them to take influential defaulters to the new bankruptcy courts - has upset purists who argue that a regulator should be setting the broad rules of the game rather than interfering in operational matters".
Going forward, the investigation will reveal and highlight the extent to which Modi and his cohorts conspired to defraud the bank thereby sending tremors across the banking sector. Some may ask the question, in light of PNB not doing the requisite due diligence; whether the government should fund state run banks without them clearly laying out their risk management practices.
This not being the first time PNB has had problem of being defrauded. As the Economic Times reports, the bank has been hit by several frauds by jewelers - including two of the biggest by Winsome Diamonds and Shree Ganesh Jewelers who used the same methods as Modi. This makes it clear that lessons were not learned.
As Santosh Trivedi who spent 40 years with PNB as its senior manager of audit and inspection said, "The apparent failure of anyone to notice the largest fraud in Indian banking history until this January reveals a "rot" in the state financial sector that goes beyond one lender".
More columns by Varun Sukumar