One can find thousands of write-ups on Nirav Modi-PNB Fraud case, the most debatable topic in the news but only until some other sensational news comes up. In almost every article, you will come across phrases such as Letters of Undertaking, SWIFT, and CBS. But is it that easy to decipher a scam that involves more than USD 1.7 billion or INR 11,000 crore?
So here we discuss the scam in a plain language, sans any technicalities so that the common man, who keeps his savings in banking institutions and avails other services like borrowing, doesn’t need to scratch his head.
- To begin with, we must know that gems and jewelry industry are a key importer of rough gems, which the industry players process and then sell these finished goods in the domestic/ foreign market. So, when the player needs money to import rough gems, he approaches banks for credit.
- One of the forms of this credit facility is through Letter of Undertaking (LoU) whereby a bank guarantees to other foreign-based banks or foreign branches of Indian banks that should these other banks extend a short-term loan of generally 90 days to the importer, the LoU issuing bank will make good any losses even in the worst-case scenario of importer defaulting on due date.
- Punjab National Bank, a public-sector bank second only to the behemoth of the industry, State Bank of India, through its Mumbai branch entered into similar contracts with Nirav Modi firms.The catch, however, is that while in general practice, letters of undertakings are issued only when there exists adequate collateral pledged by the importer, here some corrupt officials skipped this crucial step.
- Once 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 banks obviously believed that there lies an underwriting from one of the most reliable public-sector banks extended loans in foreign currency. Upon instructions from the firms of the borrower, Nirav Modi, the amount received in PNB’s Nostro account was credited to the account/s of suppliers of rough gems.
- And this wasn’t a one-time event. Since 2011, PNB officials had conspired with Nirav Modi and have issued unauthorized LoUs even when previous loans were never repaid. This could remain undetected since corrupt officials did not report SWIFT messages in core banking system (CBS) of PNB.
- All in all, the connivance between bank staffers and Nirav Modi has cost Punjab National Bank a third of its market value.
Also read: How to Tackle Banking Sector Woes
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