As details of the Nirav Modi fraud emerged, I was vividly reminded of a conversation that I once had with my boss, a seasoned and experienced banker.

This was in the early 1990s and as head of the project and corporate finance division, I was seeking approval for a complex long-term project finance proposal. After going through the credit appraisal, he said, “This is an excellent analysis of the project, and of the promoters’ ability to pay—but have you assessed their intent?”

And then he went on to say something I would never forget. “You must, of course, do your due diligence on the project and promoter. But before you make a final decision on whether to lend or not, sit down with your borrowers and look them in the eyes. And then make an assessment of whether you would trust them with your own money. If the answer is yes, go ahead; if not, don’t. And remember sometimes the richest people can be cheats and the poorest can be the most honourable”.

Prophetic words indeed! They stood me in good stead throughout my banking career, and, I believe, constitute the best possible guidance for anyone in the financial services world.

In the current glittering Modi-Choksi saga that has captured the attention of the nation, this advice would have served bankers in PNB and their correspondent banks well.

The facts of the Rs 280 crore fraud are clearly articulated in the FIR filed by PNB. Two officers in the foreign exchange department of PNB’s corporate branch in Fort, Mumbai, Gokulnath Shetty (who retired in May 2017) and Manoj Kharat, are alleged to have issued eight letters of Undertaking (LoUs) via SWIFT, in favour of Nirav Modi’s group of companies, for the import of pearls from Hong Kong, totalling $44.22 million, in February 2017, without any collateral and without recording these in the bank’s core banking system.

On January 16, Nirav’s team approached the corporate office for fresh LoUs, and on being asked to furnish cash margin, protested that they have enjoyed these facilities since 2011, without any collateral, thus raising a red flag with the officer who replaced Shetty. On January 25, 2018, the buyers credit facilities that Nirav Modi’s companies had drawn from the overseas branches of Allahbad Bank and Axis Bank against the PNB LoUs, were not repaid on the due date, raising another red flag—especially when PNB realised that there was no record of these facilities in the bank’s books.

On February 14, 2018, PNB disclosed in a filing to the Bombay Stock Exchange (BSE) that “fraudulent and unauthorised transactions” were estimated at $1.77 billion (about Rs 11,400 crore), through 293 fraudulent LoUs. On February 27, the bank announced that the fraudulent transactions could “increase by a further $204.25 million (about Rs. 1,323 crore)”, thus taking the grand total to $2 billion, or Rs 12,700 crore. Viewed in the context of the already high non-performing assets (NPAs) of PNB (Rs 57,630 crore as at September 2017), this was seriously bad news.

Fitch Ratings soon placed Punjab National Bank’s viability rating of ‘BB’ on Rating Watch Negative, adding that “the fraud raised questions on both internal and external risk controls and the quality of management supervision, given that it went undetected for several years”. Credit rating agency Moody’s also placed PNB under review for a ratings downgrade, citing fraudulent transactions. Currently, the bank has an overall rating of Baa2 and a foreign currency deposit rating of Baa3/P-3 with Moody’s.

Since February 14, when the fraud was first disclosed by the bank, PNB shares have lost nearly 40% of their value—a drop in market valuation of approximately Rs 15,600 crore. Shares of other bank stocks, the BSE Bankex and the Sensex have all taken a hit.

Prima facie, there seems to have been decisive action . Why then is there a continuing sense of disquiet about this fraud?

The shocking thing about Nirav Modigate as the case is now being called, is not that a fraud took place. Bankers have known from time immemorial that fraud and collusion are inherent risks of the banking business and that certain departments are particularly susceptible, which is why there are control measures put in place to mitigate this risk.

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What defies the imagination is that multiple lines of defence—the operational risk, internal audit and concurrent audit teams of PNB, external auditors, and RBI auditors—all failed to detect a fraud of this magnitude over such an extended period of time.

The fact that the management and the board of PNB, the management and the board of the RBI, and the department of banking su - pervision in the Ministry of Finance, also all failed to notice this is even more astonishing. Given that Rs 12,700 crore exceeds one-third the capital of the bank, this is a number that should have sent alarm signals right through the system. The fact that it did not seems to indicate a complete failure of governance.

The problem with the Nirav Modigate is that it points to widespread incompetence, collusion, and corruption not just within PNB and the correspondent banks involved, but also within the RBI and the Ministry of Finance. Viewed in the context of the huge black hole of bad loans of public sector banks (Rs 7.34 lakh crore as at September 2017) in which leading corporate houses and companies accounted for approximately 77% of the total gross NPAs, it also highlights the increasing menace of cronyism.

The Nirav Modi fraud has cast a doubt on the credibility of the entire banking system. Are we talking of 12,700 crore or multiples of this number? Can we trust any of the players? And who in the end is accountable to the helpless depositors of PNB or indeed to the Indian tax - payer who will ultimately have to foot the bill?

Alternatively, is it possible that what Nirav Modi’s lawyers claim is true? That facilities were honoured and repaid regularly on the due dates and it was only the last LoUs that were not paid? If this is the case, then while the cumulative value of fraudulent LoUs issued could amount to Rs 12,700 crore, could this have been a “performing asset” for most of its revolving life, since 2011? In this case, PNB’s NPAs could possibly be restricted to a few hundred crores (which, of course, could mount going forward as the viability of the business is now in serious doubt). If this is true, then suddenly everyone, especially, PNB, RBI, and the Ministry of Finance all appear, in a somewhat better light—and at the very least, less incompetent.

And suddenly what becomes clear, is that in the media frenzy and political one-upmanship that has surrounded this case, many basic questions have not been answered. We know “how” the fraud took place. But given that several weeks have elapsed since the fraud was discovered and the CBI has been interrogating officials, it is surprising that neither the MD and CEO of PNB, nor the governor of the RBI, nor the finance minister have answered simple questions such as:

  • What are the actual NPAs of Nirav Modi’s companies in PNB, and other banks?
  • Why did Shetty and Kharat issue the LoUs? (For example, were they paid or were they pressurised to do so?)
  • Why were operational procedures not followed? (For example was this because of incompetence, corruption and collusion, or pressure from above?)
  • Why did the internal, concurrent, statutory, and RBI auditors not detect the fraud? (For example, was this a performing asset and hence not easily visible, incompetence, corruption and collusion or pressure from above?)
  • Why did senior management and the board of PNB, RBI, and the Ministry of Finance not notice a fraud of this magnitude?
  • Who is accountable in each of these institutions for fraud and bad loans and does s/he have the autonomy to deal with such problems/borrowers? And last but not least
  • Where does the buck stop?

Given that the answers to the questions above must already be with the RBI and finance minister, it is a mystery that they do not release them. Given the silence of those who should know, people have naturally assumed the worst—and a host of conspiracy theories have started doing the rounds. Some of these are quite bizarre but others, such as this is a cunning back door plan to privatise banks and/or that this is a precursor to the hated bail-in clause in the proposed FDRI bill, are gaining currency.

As India’s second largest PSU bank, PNB is a systemically important financial institution. Bad news in the financial services world tends to be contagious and should be dealt with swiftly and clearly so that confidence is restored, both in the banking system and in the institutions that uphold it.

The governor of the RBI and the finance minister would do well to recognise that what they are confronting is more than just a fraud at one bank—it is a crisis point for the entire Indian banking system .

To use an analogy, what has happened in Nirav Modigate is like a major railway accident. Traditionally, in India, whenever a big rail accident takes place, it is the railway minister who is held accountable—there is little credibility when faulty old tracks or linesmen are blamed, notwithstanding the fact, that may be the initial cause.

Our banking sector has had too many such accidents in the recent past, and the double shocks of mounting NPAs and major frauds, has dealt it a severe blow. Dealing with a crisis of this magnitude requires both leadership and honesty and clarity of communication, which sadly have been lacking so far. Someone needs to step up fast and take accountability.

Or else the ripple effects of Nirav Modigate could cost a great deal more than the fraud of Rs 12,700 crore and the Rs 15,600 crore loss in PNB’s market capitalisation. It could dent trust and credibility in India’s entire banking system, not just in the global community but amongst Indian depositors, tax payers and citizens. This is not a price to be paid lightly.

( Views expressed are personal. )

(The column was originally published in 15 March-14 June special issue of the magazine.)

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Meera H. Sanyal is a former chairperson and CEO of Royal Bank of Scotland, India and of ABN AMRO Bank, India.

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