Explainer: How PNB says it fell victim to India's biggest loan fraud

Gitanjali Gems

26/02/2018 09:26

(Updates item first issued on Feb. 15 with additional details) 
    By Devidutta Tripathy 
    MUMBAI, Feb 26 (Reuters) - India's Punjab National Bank 
 PNBK.NS , the second-biggest state-run lender, stunned the 
country's financial sector this month when it announced it had 
discovered an alleged fraud worth $1.8 billion at a single 
branch in Mumbai. 
    The fraud, by far the biggest ever detected by an Indian 
bank, comes to light at a time when lenders - especially 
state-run banks - are hobbled by $147 billion in soured loans on 
their books, a problem that has slowed lending and hurt the 
economy. 
    The following is an explainer on the PNB fraud and its 
implications for other lenders and India's banking sector:       
     
    WHAT IS THE FRAUD ALLEGATION ABOUT?     
    On Jan. 29, PNB filed a criminal complaint with India's 
federal investigative agency against three companies and four 
people, including billionaire jeweller Nirav Modi and his uncle 
Mehul Choksi, the managing director of Gitanjali Gems  GTGM.NS , 
saying they had defrauded PNB and caused a loss of 2.8 billion 
rupees ($43 million). 
    In a regulatory filing on Feb. 14, the bank updated the sum 
involved in the fraud to 113.94 billion rupees ($1.77 billion), 
which it said was determined after further investigation. 
    The bank alleges that two junior employees at its Brady 
House branch in Mumbai colluded with companies belonging to Modi 
and Choksi, and issued fraudulent "letters of undertaking", or 
LoUs, without asking for any margin money as security, even 
though the firms did not have any pre-approved credit limit. 
    The firms, PNB says, raised short-term credit from overseas 
branches of other Indian banks based on these LoUs, and in some 
instances fraudulent foreign letters of credit (FLCs) in favour 
of foreign suppliers.     
     
    HOW DID THE FRAUD COME TO LIGHT? 
    PNB says that on Jan. 16 a representative of one of the 
accused firms presented a set of import documents to the Mumbai 
branch and requested buyers' credit to pay overseas suppliers. 
Since they had no pre-arranged credit limit, the branch official 
asked the companies to put down the full amount as collateral so 
the bank could issue LoUs to authorise the credit. 
    When the representative argued they had used such facilities 
in the past without keeping any money as collateral, PNB scanned 
its records and found no trace of any transactions, according to 
the bank's account. 
    It then found that two junior employees had issued LOUs over 
the SWIFT interbank messaging system without entering any of 
these transactions on the bank's own system. Such transactions 
went on for years without detection, PNB said. 
    Bankers say in many Indian banks the SWIFT system, which is 
used for international transactions, and the core banking system 
work independently of each other. In PNB's case, it said the 
outstanding LoUs were not available on its core banking system 
run on Infosys's  INFY.NS  Finacle software, and so went 
undetected.      
     
    WHO ARE THE PEOPLE AND COMPANIES ACCUSED OF INVOLVEMENT AND 
WHAT HAVE THEY SAID? 
    PNB accused three companies - Solar Exports, Stellar 
Diamonds and Diamond R US - it said belonged to Modi, a high-end 
jeweller who runs his eponymous Nirav Modi stores spread from 
New York to Beijing. Modi was worth $1.7 billion last year, 
according to Forbes rankings. 
    Modi's companies colluded with the bank staff, PNB said, 
adding that it suspected some officials at foreign branches of 
other Indian banks that extended credit were also involved. 
    It also named Gitanjali Gems, Gili India and Nakshatra - 
companies promoted by Choksi. 
    A lawyer for Modi has denied any wrongdoing by his client. 
Modi himself has not commented publicly, but wrote to PNB in a 
letter, a copy of which was seen by Reuters, that his firms owed 
"substantially less" than the total exposure reported by the 
bank.  urn:newsml:reuters.com:*:nD8N1PZ019 
    Gitanjali has also denied Choksi's involvement in the fraud. 
Choksi, in an open letter to employees on Friday, maintained his 
innocence and advised them to look for other jobs, as his assets 
had been seized and he was unable to pay salaries.  urn:newsml:reuters.com:*:nL4N1QE0AR  
       
    WHAT ARE THE AUTHORITIES DOING? 
    The Central Bureau of Investigation (CBI) has so far 
arrested 12 people - six from the bank and six from Modi and 
Choksi's companies. All have appeared in court and been held in 
custody for further questioning. 
    The Enforcement Directorate, a government agency responsible 
for fighting financial crime, says it has seized diamonds and 
jewellery worth 56.74 billion  rupees ($875 million) after 
searching Nirav Modi's home and offices. It has also seized nine 
of his luxury cars including a Rolls-Royce Ghost.  urn:newsml:reuters.com:*:nL4N1QC32W 
    The Reserve Bank of India this week wrote to banks asking 
them to ensure their SWIFT system was integrated with their main 
banking software by April 30.  urn:newsml:reuters.com:*:nL4N1QD30B 
    The Finance Ministry has also written to banks telling them 
to take effective steps to avoid any similar fraud.  urn:newsml:reuters.com:*:nD8N1PZ018 
    The government has said it will not spare wrongdoers in the 
PNB case.  urn:newsml:reuters.com:*:nL4N1Q60QN 
         
    WHO ASSUMES THE LIABILITY?  
    PNB has said the transactions are "contingent" in nature and 
it is ready to honour "bona fide" commitments. Reacting to media 
reports, it said on Friday it had received no instruction from 
the RBI or the government to pay the other banks who gave loans 
based on the fraudulent guarantees. 
    Several banks that extended loans based on the PNB 
guarantees and are at risk of losing money want PNB to pay up, 
according to banking sources. 
    In a Feb. 12 "caution notice" addressed to chief executives 
of 30 banks, PNB said the other banks also have a share in the 
blame as they "overlooked" certain Indian central bank rules. 
    PNB has said it is following all "lawful avenues available" 
to recover its dues and it has asked Modi to respond with a 
"concrete and implementable" repayment plan.  urn:newsml:reuters.com:*:nL4N1QC32W 
 ($1 = 64.7775 Indian rupees) 
 
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GRAPHIC- India's $1.77 billion bank fraud IMG    http://tmsnrt.rs/2C9xTKf 
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 (Reporting by Devidutta Tripathy; Editing by Alex Richardson) 
 ((devidutta.tripathy@thomsonreuters.com; +91 84518 40430; 
Reuters Messaging: 
devidutta.tripathy.thomsonreuters.com@reuters.net)) 
 
Keywords: PUNJAB NATL BANK FRAUD/EXPLAINER (UPDATE 1, EXPLAI