Nirav Modi firms did not defraud country’s second largest government bank, Punjab National Bank (PNB), in a single stroke; it was rather a systematic, prolonged mischief that lasted for seven long years. Had this been an outcome of a one-time lapse, banking sector could have stood vindicated since frauds can crop up in any enterprise, public or private, based in any jurisdiction across the globe.
The question is, ‘What are the loopholes that led to the largest bank fraud in India?’
Also read: What is PNB Scam – An Easy Explainer
- Failure of linkage of SWIFT to Core Banking System (CBS)
When a Letter of Undertaking (LoU) is issued, a message to foreign branches of Indian banks is sentvia SWIFT (Society for Worldwide Interbank Financial Telecommunications). Interested banks pick these messages, discount the LoU and then credit the Nostro account of LoU Issuing bank (held abroad in foreign currency) with the amount requested.
What happened in the PNB case was that foreign branches of Indian banks relied on unauthorized LoUs on the SWIFT interbank messaging system, issued by two junior employees without entering the transactions on the bank’s own system. The failure of linkage of SWIFT to CBS facilitated the employees to issues LoUs, not backed by adequate collateral, without reporting it to bank’s own system.
However,Reserve Bank of India (RBI) has asked banks, who have not integrated SWIFT and CBS, to complete the requirements by 30 April 2018.
- Lack of proper internal controls on bank employees and effective orientation and training programmes
There was a clear lack of internal controls at PNB branch. As per the standard practice in banks, employees are rotated in every three years. In this case, one of the accused employees stayed posted in the same department for seven years.
Sharing of passwords is prohibited among bank staff. This is strictly taught during the training that employees have to compulsorily undergo. In PNB fraud case, one employee used two to three officers’ passwords, which raises questions about the training itself.
There is no doubt that it was the collusion of PNB’s Mumbai branch officials with Nirav Modi firms that facilitated the fraud, and investigating agencies are said to have napped these culprits. These officials issued unauthorized Letters of Undertaking (LoU) and also made sure that when these LoUs were transmitted through SWIFT, a corresponding entry was never to be made in the core banking system (CBS) of the bank.
This gives rise to another doubt. Did branch level officials have the expertise and authority to do so, or were they aided by other personnel?
Once SWIFT messages were picked up by foreign branches of Indian banks that were willing to give loans, the picture shifts to the branch that handles Nostro (held overseas in foreign currency) account. This is usually done at head office level by a dedicated Forex team. It was here that high flow of money coming into the Nostro account should have raised red flags and these should have been communicated to higher management.
Now either the forex department failed to notice these suspicious transactions or they themselves were complicit in the wrongdoing.
- Non-efficacy of bank audits
Finally, once we fix the liability of staffers at the bank, the role of outsiders should also be checked. Owing to vulnerability to frauds, all enterprises have checks in place, such as risk management teams, audit departments, and vigilance personnel. The defrauded entity in this case too had checks at various levels, for example, auditors assess branch level records and statutory audits are also done at the highest levels. But neither of the agencies, internal or external, could detect the ongoing scam and it came to light only when the bubble became too large to be sustained.
PNB fraud does raise questions on the role of auditors. Bank’s concurrent auditors,internal auditors, statutory auditors and even RBI auditors failed to smell a rat in the fraud case involving crores of money.For seven years, no auditor raised any doubts on the issuance of LoUs without collateral, transmission of SWIFT messages, the credit of money by other banks into PNB’s Nostro account and subsequent transfer from Nostro to accounts of suppliers of Nirav Modi firms.
Concurrent auditors and internal auditors, who check the accounts at the branch level, could have easily detected the fraud. However, the only explanation for not being able to do this is lack of training/expertise and willingness.
- Lack of vigilance on part of RBI and government
Reserve Bank conducted the last audit in PNB nine years ago on March 31, 2009, when for a mid-corporate bank, like PNB’s Brady House branch, that deals with high net worth individuals, the audit is supposed to be done annually.
In 2014-15, the Government, arbitrarily decided thatselection and appointment of statutory auditors be delegated to Public Sector Banks instead of Department of Financial Services doing the job which opened gates for collusion between the auditors and bank management.
All this bring out the lack of vigilance on part of the RBI and the government, either intentionally or unintentionally.
Even if one may say that not everyone colluded in the offense, it is sure that there was severe lack of sense of duty at all levels. It should then be expected that junior level staffers would not be made scapegoats and one of the largest corporate frauds will be probed in a nondiscriminatory manner.
Suvipra view
There is an urgent need for banks to plug all the possible loopholes. Lack of integration of CBS and SWIFT is not the only loophole. Bank’s Internal Control system needs to be strengthened, proper training should be conducted for staff to equip them with the knowledge of possible frauds and how to prevent them, new technology like blockchain (Also read: Quietly Seeping Into Financial Infrastructure – The Blockchain) should be introduced to aid the auditing process and RBI and the government should do every bit to protect the financial backbone of the country from any frauds in the future.
Also read: How To Tackle Banking Sector Woes
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