A major financial scam hit the headlines in January 2018 involving “fraudulent and unauthorized” transactions involving letters of undertaking (LoU, guarantee) to Antwerp-based diamantaire Nirav Modi, amounting to over Rs. 12,500 crores at the Punjab National Bank (PNB). Initial reports suggest that this originated at a branch in Mumbai where a manager allegedly took advantage of the incomplete integration of the bank’s core banking platform with the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network. The LOUs provided Nirav Modi access to huge foreign exchange loans provided by banks, including the State Bank of India, Axis Bank, Allahabad Bank and Canara Bank. The diamantaire’s subsequent default on the loans blew the lid.

It is well known that the banking industry all over the world, including India, is a highly regulated industry. Yet, with so many regulations and agencies monitoring it, Indian banks have been subjected to high profile, high value frauds with a regularity that is numbing. What is even more galling is the apparent ease with which the fraudsters seem to get away and live happily ever after. It makes us wonder if the authorities are really capable of providing a safe and secure banking environment for the people in India or are just paper tigers. Whatever the truth, the money has disappeared and there is little hope of retrieval.

This scam is reminiscent of the fraud that bought down Barings Futures Singapore (BFS) in the late 1990s. Investigations had then revealed that Nick Leeson, a broker at the Bank’s Singapore office, allegedly unbeknownst to the management, had entered into unauthorized speculative trading that bought the bank down.

It is precisely to fix these types of frauds by lone wolves as well as risks arising from technology-related issues that the Bank for International Settlements (BIS) brought out guidelines for enhanced scrutiny in the subsequent release of the Basel II guidelines. These robust guidelines have further been expanded in Basel III release and have largely succeeded in plugging these types of frauds worldwide. Like many countries, India too has mandated its banks to adopt these guidelines to bolster their risk management capabilities.

It will be instructive to look at the level of scrutiny banks in India, in particular, are subjected to. Firstly, each of these banks have their own set of guidelines for periodic – usually annual – mandatory audit of high value transactions, both by internal as well as external auditors. This means, in the PNB scam case, at least ten internal and external audits of the five banks must have reviewed the same high value transactions of Nirav Modi at different points in time.

In addition, these banks themselves conduct periodic governance, risk and compliance audits that would specifically look into any operational or enterprise risks. Over and top of all this, the Reserve Bank of India (RBI) meticulously inspects the banks regularly. This includes onsite as well as offsite surveillance of the banks by dedicated teams.

The million dollar question on everybody’s mind is how did the diamantaire manage to pull wool over the eyes of PNB and the regulators? The obvious answer is that the auditors and agencies appear to have been silenced by invisible hands.

A look at the data published by RBI is indeed telling. The non-performing assets (NPA) or bad loans as a percentage of gross loans jumped from 6.55% in 2015 to 12.90% in 2016 and then to 12.53% in 2017. (Source www.rbi.org.in)

It must be mentioned here that loans take several payments cycles and considerable delinquency (non-payment of dues) and/or a default to be classified as an NPA. In other words, Nirav Modi’s loan accounts and consequent exposure to banks arising out of the letters of undertaking would have been in active audit and regulatory scrutiny for a considerable amount of time before it became a hot potato.

The report itself points to the fact that RBI knew about this precipitous jump in NPAs at PNB in 2016 or even much earlier. This would have automatically raised red flags internally and triggered closer review by the regulator. There is absolutely no gainsaying the fact that Dr. Raghuram Rajan, the then Governor of the RBI, must have been fully aware of this scam.

As is the wont of such high profile scams, many questions, including the most obvious ones, remain unanswered. If data available in public domain was already pointing to almost doubling of delinquent accounts in just twelve months at PNB, what actions did the regulators take? Were they prevented from discharging their duties? If so, by whom? What was the role played by the then Ministry of Finance?

At least some things can be deduced from the above report. PNB must have been aware of this much before the RBI or the Ministry of Finance were informed since they compiled and sent the data to RBI. The RBI knew what was going on at PNB long before the matter became public. Hence the arrest of low level officers at PNB or the alleged lack of connectivity to SWIFT are nothing but scapegoats in what now appears to be a premeditated loot of public money.

The PNB executive management and the auditors cannot escape responsibility for their negligence and apparent inaction, for that is tantamount to abetment of this colossal crime. The need of the hour is to revamp the bank’s executive management and clean up its audit and compliance processes. PNB has to step up the transparency in disclosures and come clean on the fraud so that the real culprits face the law.

Recent media reports have pointed to the involvement of a senior politician of the UPA regime in this scam. Fingers point to a former minister in the UPA, who has also been at the center of multiple other corruption accusations. Given India’s post-independence history of corruption, this comes as no surprise at all. That the scam leaked into public domain is the real surprise, if at all there is any.

Banking, as we all know, is a business built on trust and relationships. Repeated breach of public trust in banks in India is symptomatic of a deeper malaise in the banking system. It is now incumbent on the government and its investigating agencies to get to the bottom of the PNB scam and book the culprits – be it lowly officers or the high and mighty political overlords – and bring them to justice. Any delay will only widen the public’s trust deficit in Indian banks.