Gem of a scam: On PNB fraud

Gem of a scam: On PNB fraud

Context:

• A regulatory filing to the stock exchanges by Punjab National Bank has blown the lid off a ₹11,500-crore fraud.

Introduction:

• It is the largest such scam in India, it was perpetrated by a maverick diamond merchant in collusion with bank officials at a single branch in South Mumbai.
• For India’s second largest bank to be defrauded in the manner suggested that there has been heightened scrutiny of public sector bank’s operations in the last few years.
• The PNB has also issued a note to all the banks cautioning them against the modus operandi adopted in the fraud.
• The bank found that the beneficiary companies were maintaining only current accounts with the branch and had not been sanctioned any credit limit.

What has happened?

• Recently, PNB found that the SWIFT system had been misused by a junior-level branch officials, who had fraudulently issued letters of undertaking (LoUs) on behalf of some companies for availing buyers credit from overseas branches of Indian banks.
• Preliminary investigation into the alleged fraudulent transactions worth ₹11,500 crore has revealed a complete breakdown of supervision and auditing mechanism in Punjab National Bank’s Mumbai branch and overseas branches of the other banks concerned.
• The transactions remained undetected for almost seven years, despite the fact that the bank conducts internal and external audits on a regular basis.
• Overseas branches of the other banks, which released payments on the request for settlement of import bills, also did not flag the discrepancies for such a long period.
• The bank has pinned the whole blame on the then Deputy Manager, Gokulnath Shetty, and a low-rank staffer for the fraudulent issuance of Letters of Undertaking (LoU) on behalf of the three firms associated with diamond merchant Nirav Modi and his family members.
• It is alleged that bills were also cleared for payments through PNB’s Nostro accounts with other banks that deal in foreign currency
• As per rules, those availing such a credit facility are required to repay the loan within 90 days of the issuance of an LoU.

SWIFT system

• In the PNB case, the accused officials misused the Society for Worldwide Inter-bank Financial Telecommunication (SWIFT) system to verify the fraudulently issued LoUs, conforming to the overseas branches of several banks that they could extend foreign exchange credit to the beneficiaries.
• The SWIFT system is mainly used for clearing international wire transfers.

Accused book under Prevention of Corruption act:

• The Central Bureau of Investigation has booked one retired and one serving PNB employee so far.
• The Enforcement Directorate has registered a money laundering case in the matter.
• It involves Mumbai-based billionaire diamond merchant Nirav Modi.

Banker-borrower nexus:

• 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.

Steps taken by Enforcement Directorate:

• The Enforcement Directorate may soon write to all the banks to report any fraudulent transaction, for speedy action against those involved.
• Alarmed by the manner in which Letters of Undertaking (LoU) were fraudulently issued to importers in connivance with certain PNB officials, the agency suspects that the same modus operandi could have been adopted in other banks to raise funds illegally in the name of settling import bills.

Letter of Undertaking(LoU):

• LoU is a bank guarantee generated on behalf of importers for payments abroad.
• Under this arrangement, the issuing bank agrees to unconditionally repay the principal amount and interest thereupon. It remains valid for three months.