Punjab National Bank detected fraudulent transactions worth Rs 11,300 crore aas found through SWIFT trail that one junior level branch official unauthorized and fraudulently issued Letters of Undertaking (LoU) on behalf of some companies belonging to Nirav Modi Group for availing buyers' credit from overseas branches of Indian Banks. None of the transactions were routed through the Core Banking Solution or CBS system, thus avoiding early detection of fraudulent activity.
What is LoU?
Letter of Undertaking is a bank guarantee and is issued for overseas import payments. A bank, while issuing LoUs for a client (here Nirav Modi), agrees to repay the principal and interest on the client's loan unconditionally. When an LoU is issued it involves an issuing bank, a receiving bank, an importer and a beneficiary entity overseas. PNB officials allegedly used their access to SWIFT messaging system (used for overseas transaction) and verified guarantees given on LoUs without taking necessary sanctions. As a result, overseas branches of many Indian banks gave forex credit.
What is SWIFT?
When an LoU is issued, the message of credit transfer is conveyed to overseas banks through the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system. This is a significant information as it gives the bank's consent and guarantee. To issue SWIFT, an official has to log in and fill up confidential information such as the account number and SWIFT code. It generally has three layers of security - a maker, a checker and a verifier within the core banking system before it is issued.
What is CBS?
CBS refers to Core Banking System where all branches are inter-connected to ensure that the bank customers - regardless of their home branch - are able to operate their account and transact in any of the member branch located anywhere in the world. After the advent of this system, a customer is no more customer of a branch, but s/he becomes customer of bank. All the transactions are updated real-time. So, if you are wondering why the PNB couldn't detect the fraud earlier, it is because the PNB official did not rout the transactions through CBS, which would have given real-time data on transacted business.
Who are Involved?
PNB alleges that Modi worked with a former PNB employee, Gokulnath Shetty, who was posted at a PNB branch in Mumbai from where the fraud originated. Shetty was a deputy general manager in the foreign-exchange department looking after import payments.
The fraud allegedly dates back to 2011. Between then and January 2017, Shetty issued several fake PNB letters of undertaking -- without any collateral -- for Modi.
The bank claims they then bypassed the lender’s internal messaging system in order to avoid detection, and placed instructions via the SWIFT global payment system asking overseas branches of Indian banks to fork out the cash as loans
How did the scam come to light?
1. There is a provision of bank guarantee known as letter of undertaking (LOU) under which a bank allows its customer to raise money from another Indian bank's foreign branch in the form of a short term credit. The LOU serves the purpose of a bank guarantee.
2. However, to be able to raise the LOU, the customer is supposed to pay margin money to the bank issuing the LOU and accordingly, he is granted a credit limit. But in Nirav Modi's case, neither was there a credit limit, nor did he ever give any margin money, reported Reuters.
3. 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, and Allahabad Bank. The loans were raised by Nirav Modi's firms on showing the letters of undertakings issued by the PNB.
4. 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.
5. Ideally, Nirav Modi and his firms are supposed to repay the loans but so far, all these loans have allegedly been rolled over for want of funds. In the scenario when the borrower fails to make the repayment, the bank issuing the LOU (PNB in this case) is duty-bound to honour the commitments on the behalf of its customers.
6. On Thursday (February 15), the Reserve Bank of India (RBI) reportedly directed the PNB to pay all these banks that gave loans to Modi's firm on the basis of guarantees/ LOUs issued by the state lender.
7. So in effect, Indian bank's foreign branches make payment to Nirav Modi's suppliers in the form of loans to Modi. As guarantee, the firms show the letters of undertaking issued by the PNB's Brady Road branch in Mumbai.
8. In January, the fraud was unearthed when Modi's firm requested further LOUs for paying the overseas suppliers. On this, the bank officials refused on the ground that Modi's firm need to keep 100% collateral for the same. The Modi's firm argued that no such money was kept 'on margin' in the past either. Following which, the bank officials scanned the records only to discover that there was no trace of any such transaction. This implies that the guarantees/ undertakings were issued by bypassing the rules in collusion with some PNB employees.
9. The violation of banking rules as mentioned in the point 8 above was too glaring a blunder to ignore. Hence, Punjab National Bank filed a criminal complaint with the CBI on January 29 accusing Nirav Modi and others of defrauding the bank and causing it a loss of Rs. 280 crore ($43.8 million). The complaint was filed against three companies and four people, including Nirav Modi and Mehul Choksi, managing director of Gitanjali Gems.
Who is Nirav Modi?
Nirav Modi, the man at the centre of the alleged $1.77 billion banking fraud at Punjab National Bank (PNB), is a regular on the pages of some of the world’s leading international financial dailies and fashion magazines, advertising for stores on glamorous high streets. There’s 31 Old Bond Street in London and 727 Madison Avenue in New York. In Mumbai, his store will soon replace the iconic Rhythm House at Colaba which shuttered in 2016.
Born in India and raised in the Belgian city Antwerp, the diamond capital of the world, Modi is a third-generation diamantaire.
Modi is ranked 1,234 in Forbes’s world’s billionaires list for 2017, and 85 in India. His financial worth is estimated at $1.73 billion through his jewellery design and retail businesses, according to the Forbes website.
The Nirav Modi brand is owned by Firestar Diambr>
The Reserve Bank of India (RBI) has directed Punjab National Bank to pay the entire Rs 11,300 crore owed to counterparty banks in the alleged fraud involving jeweller Nirav Modi, said two bankers aware of the development. Not doing so could lead to turmoil in the financial markets as the trust factor that’s integral to the functioning of the banking industry will be lost, which is short of funds, has in turn sought the intervention of the government to sort out the mess.
Finance Ministry on PNB Scam
Assets in the Nirav Modi fraud case involving state-owned Punjab National Bank will be recovered and nobody will be spared.