My Mother Happily Paid For Nirav Modi’s Scam

Posted by Ambar Sharma in Business and Economy
February 19, 2018

The reason for the outrage is what everyone fundamentally grasps – Nirav Modi fled the country when he was unable to pay his debts to PNB (Punjab National Bank). PNB is India’s second largest public sector bank, after SBI. The share price of PNB went down to a 52 week low on the Bombay Stock Exchange. The person who owed the money does not face any immediate consequences. He has fled with his family and is reported to be in a cosy apartment in New York.

It is not the bank’s money that he has fled with, nor is it the government’s. It is in every which way, the public’s, that is yours and mine. My mother is an honest taxpayer. She is the only person I have met who feels strongly obligated to pay tax, whereas every other person, in their rightful way expresses dismay when filing returns at how much they have to pay, that too for how little they get. This swindling of money is another example of defrauding not the bank, but the honest taxpayer.

The fraud started when Mr. Modi wanted to import diamonds and sell them in India way back in 2011. As he would be importing rough diamonds, he would need a low-interest, foreign exchange loan to get the best deal. This would only be possible by getting a loan from a foreign bank. Despite being a billionaire, he did not have enough clout to get a loan from a foreign bank. This is where the Letters of Undertaking (LoU) from PNB came in. An LoU is a letter of undertaking, not a loan. It is a liability guarantee given by a bank to a foreign bank when the firm taking the loan is unable to pay, or fails to pay.

Simply – PNB vouched for Nirav Modi to the foreign bank. The foreign banks were actually overseas branches of Indian banks. What should have happened next was that PNB must ask for collateral (security if Mr. Modi cannot pay back the loan). This never happened. No collateral for an LoU.

People struggle to keep their cars/houses if they cannot pay back simple mortgage or personal loans, and an LoU to a foreign bank was given without any security!

PNB then messaged the foreign banks via SWIFT (Society for Worldwide Interbank Financial Telecommunications), an internationally trusted bank-to-bank messaging system which transmits instructions and transactions. The money was paid in a Nostro account, which is a bank’s account in foreign currency in another bank. There is a stipulated period by which LoU issued loans need to be paid, mostly 90 days. Even this was not followed and Modi’s LoU was extended to one year. One rule for the rich, it seems.

A loan needs to be paid back. What Mr. Modi did was to run up a mountain of loans to pay the original loans back. He started rolling-over credit like it was nothing. The money he got in the original LoU, he either used for other purposes or did not earn enough to pay it back. So, he started getting more LoUs issued for over six years. This continued on and no one ever caught Mr. Modi – a true happily ever-after.

Unfortunately, the RBI changed a rule in January 2018 which required more margin money, that is, collateral for importers like Mr. Modi. When PNB went to Mr. Modi for more margin money to issue another LoU, however, his company complained that they have never had to give margin money and this was akin to extortion. This led to PNB going through previous files and finding out that all LoUs were unsecured.

The PNB’s version of events say that two junior level employees were complicit. That they did not enter the data in the CBS (core banking system) and thus it could not be detected. Along with this, the LoUs were not valid and were fraudulent in nature. PNB is saying the liability to pay the loans will not be on them as other banks did not comply with RBI rules and did not check the LoUs properly. Whatever the reason, the SWIFT message was PNB’s; it will ultimately have to pay.

If two employees could do this, what does that speak of your fraud detection mechanisms and business intelligence technology? Arrests have been made and property has been seized, although I seriously doubt the valuation of ₹5,000 crore. Still, it is not about the facts of a single case for me as a citizen, that is for the DRI, the ED and the CBI to uncover and solve, it is about the laughably poor public sector banking system we have at the moment.

₹61,000 crore was the amount of bank loan frauds in the last five years, an RTI revealed. Is this what my mother has been paying taxes for?

This is not an isolated case and will not be the last. Like Mallya and Lalit Modi, the current government should not have let him leave the country, especially when the PMO was warned in July 2016. However, that was the final act, the coup de grace. How did the internal auditors of PNB not detect this? How did the RBI auditors not detect this?

The ‘junior level branch official’ sent messages on the bank’s SWIFT channel to foreign banks through six years and the top management had no idea? Is the bank so naive that it expects the Indian public will believe this? The top management, as it always is, is to be blamed. Why, in the world, do they not do their due diligence competently before giving these loans to people who then willfully default?

PNB did not report the ₹11,400 crore in their Basel III disclosure. Of course, whilst their nostro account was building up to be over ₹11,000 crore, which the top management conveniently never noticed, they made these disclosures. This raises the question of why the CBS and SWIFT are not merged? In what way is this efficient?

The RBI, in 2013, said that we needed faster reconciliation by minimizing the number of nostro accounts and ‘close monitoring by the top management at short intervals by leveraging technology’. This was five years ago. If there was a system of fast reconciliation today, the Nirav Modi scam would have never happened. It is not about the lack of ideas, but the will to implement them in an industry frustratingly occupied by babus (bureaucrats).

The most important question – how many more importers have obtained LoUs without collateral? In how many cases is the collateral not 100%?

Whilst the BJP and the Congress fight over whose fault it is regarding the origin of the scam, the real problem of fixing the corporate governance of our public sector banks remains shortchanged. Can we please have better managers of our money?

After demonetisation, even the poorest had to associate and integrate within the banking sector. Everyone in the country had to deposit high-denomination notes in banks. This created a situation of super-liquidity which even our Economic Survey 2016-17 (page 62) concurred with. Everyone thought that at least one good deed by demonetisation would be to extend credit easily. However, NPAs are rising more than ever and banks need more capital to protect themselves against serious risk. The government launched a bank recapitalisation scheme to further infuse money into banks of₹2.11 lakh crore.

The banking sector needs serious reforms and the government needs to rise above politics and fix the public sector banks (PSBs) first, rather than playing a game of passing the stick. Our money can no longer be given to companies who willfully default. We need serious due diligence. But alas, privatization is off the table and the corporate governance reforms in PSBs remain distant.

Meanwhile, my mother continues to pay taxes happily.