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A Report on the Punjab National Bank Scam (Nirav Modi)
1. A Report on the PNB Scam
Name of the college: - Don Bosco Institute of Management and Research
Subject: - Legal Aspects of Tax
Faculty: - Prof.B.D.DHONGADE
Name: - Yohan Dโsouza
Roll no: - 12
2. Table of Contents
1. Introduction
1.1 Who are the key people involved in the scam?
1.2 Who is Nirav Modi?
1.3 About Punjab National Bank (PNB)
2. What is this fraud about?
2.1 The money involved
2.2 What is Letters of Understanding (LOU)?
2.3 What is SWIFT?
2.4 What is CBS?
2.5 Why is the CBS/SWIFT integration important?
2.6 Fake LoUs were issued
2.7 Locations of NOSTRO accounts
2.8 How did this scam come to light?
3. Who bears the brunt?
4. Loose ends
5. Conclusion
5.1 What comes next
6. Bibliography
7.
3. 1. Introduction
On the 14th
of February which was Valentineโs Day, one of Indiaโs biggest banks
disclosed a $1.77 billion fraud allegedly by one of the countryโs richest man. A man
who deals in pearls and diamonds. Shares of the lender, Punjab National Bank
(PNB), plunged on the news, dragging down other lenders when it said that the scam
may extend to multiple banks. The scam became public after a First Information
Report (FIR) was filed by a PNB official against other bank employees for the issue
of fraudulent Letters of Undertaking (LoUโs) to Nirav Modiโs firms. Later, a fraud
report filed by PNB revealed that the scam amount was much higher. Here is what
we know about the case:
1.1 Who are the key people involved in the scam?
In its complaint to CBI (Central Bureau of Investigation) -- PNB alleged that the fraud
was led by Nirav Modi, a jeweller whoโs dressed Hollywood and Bollywood actors
including Kate Winslet and Priyanka Chopra. Modi is 85th on Forbesโs 2017 list of
Indiaโs richest people and, at 47, is one of the youngest. Let us look further into who
Nirav Modi is.
1.2 Who is Nirav Modi?
Nirav Modi (born 1970/71) is a businessman, and the founder of โNirav Modiโ global
diamond jewellery house established in 2010. Born into a Gujarati family, Modi
founded Firestar Diamond and has a booming retail business across top cities of the
world including Delhi, Mumbai, New York, London, Hong Kong and Macau. In 2015,
the inauguration of his first store in New Yorkโs Madison Avenue was attended by
Donald Trump, Fortune India reported. Modiโs retail market presence has expanded
in recent years marking him as one of the youngest Indians in the Forbes Billionaires
List 2017.
While his family was in India, the billionaire businessman grew up in Belgium, which
is known as the Centre for international refined diamond trade. Though he went to
4. Wharton Business School, he dropped out and moved to India to train in the
diamond trade under his uncle. Years later, he started the โNirav Modiโ jewellery
brand and is known to have rich clients in the international market featuring high-end
jewellery collections. Last year, Bollywood actress Priyanka Chopra was also roped
in to be the global ambassador for the Nirav Modi brand.
1.3 About Punjab National Bank (PNB)
Punjab National Bank, popularly called P. N. B., initially started its business on 12th
April of the year 1895. With their mission to provide banking services to the un-
banked, they aim to be the leading player in global banking. Over the time, they have
become a known name, especially in the Indo-Gangetic plains. The huge network of
this bank includes over 5, 100 offices, which include 5 overseas branches and more
than 60 million customers. This bank has continued to maintain their leadership
position for its strong fundamentals, superior brand image as well as huge franchise
value.
5. 2. What is this fraud about?
It began with diamond firms approaching PNB for opening letters of credit for import
of rough stones. As per the terms of the LoC, a common banking tool, PNB would
pay the overseas suppliers on behalf of Nirav Modiโs firms within a certain period
(typically three months) and recover the money from Modi. Itโs a market practice to
extend the LoC if the client (i.e., NM) is unable to cough up the money at the end of
the LoC tenure.
2.1 The money involved
The fraud amount adds up to โน11,394 crore, based on PNBโs February 12th
intimation to the stock exchanges. This can be broken up into the following:
๏ท โน6,228cr - Fraud amount which appears to have accrued before 2017
๏ท โน280cr - Amount issued through 8 LoUs due for payment on 25th
January,
2018
๏ท โน3,032cr - Value of 143 fraudulent LoUs issued to the Gitanjali Group of
companies between March 1st
and May 2nd
, 2017
๏ท โน1,854cr โ Unauthorised Letters of Credit that were also issued to the
Gitanjali Group of companies
Later the bank informed that this amount could rise by โน1,330 crore. The CBI FIR
reports lists out fraudulent LoUs and LoCs issued in 2017 amounting to โน5,166
crore. The rest, amounting to over โน6,000 crore, appear to have been issued
between 2011 and 2016.
2.2 What is Letters of Understanding (LOU)?
Letters of Understanding or LoU refers to the bank guarantee issuing for overseas
import payments. In short it enables the payment of the customerโs offshore
suppliers in foreign currency. If the importer fails to make the payment on the due
date, the bank honours the commitment. Hence while issuing a LoU, a bank agrees
6. to the client to repay the principal and interest unconditionally. Here, the bank allows
the customer to raise money from another Indian bankโs foreign branch, in the form
of a short-term credit. Through LoU, one bank tells another they would meet
customerโs liability.
The customer has to pay some margin money (cash margin) to the bank issuing the
LoU (usually 100%) and he will be granted a credit limit. But in this case, there was
no credit limit and Nirav Modi did not give margin money. Nirav Modiโs three firms-
Diamond R Us, Solar Exports and Stellar Diamonds managed to pay rough stones to
its customers on a regular basis. The payment was made through loans by different
banks including Allahabad Bank, and Axis Bank. Modiโs firms raised the loans by
showing the LoUs issued by the PNB. But there was no official record of any Letters
of Understandings in the PNB.
In a situation when a customer fails to repay the loan, the bank issuing the LoU have
to pay all these banks that give loans to a borrower on the basis of the LoU issued
by the lender.
A complaint was filed by PNB with the CBI accusing Nirav Modi and others of
defrauding the bank and causing loss of โน280 crore. The PNB, according to a report
by the Scroll, has said that it would repay back the liabilities they were responsible
for.
2.3 What is SWIFT?
It is a messaging network for securely transmitting instructions for all financial
transactions through a standardised system of codes. The instructions regarding
LoU is sent through a system called Society for Worldwide Interbank Financial
Telecommunication (SWIFT). This system is trusted by all other banks since it has to
be endorsed a supervisor. According to the note by PNB, junior level branch official
sent instructions to the foreign branches behalf of the PNB which was unnoticed by
the bank.
2.4 What is CBS?
7. CBS stands for the Core Banking System where all branches are interconnected. It
enables customers to operate their accounts to avail banking services from any
branch of the bank on CBS network. The customer here comes to the bankโs
customer and no more acts as a branch customer. Customers of CBS branches will
get all the banking facilities from any other CBS branch from anywhere in the world.
In CBS all the transactions are updated on a real-time basis. The PNB could not
detect the fraud since the official did not route the transactions through CBS.
Together the SWIFT and the CBS need to be integrated properly.
2.5 Why is the CBS/SWIFT integration important?
Normally a credit limit is first set in the CBS, which in turn triggers SWIFT messages
confirming the bankโs commitment โ in this case the guarantee it extends through
LoUs, Non - integration of SWIFT and CBS in the case of PNB has allowed stand-
alone messages to be sent out without making entries in the CBS.
2.6 Fake LoUs were issued
This is done on the basis of Letters of Undertaking (LoUs) given by the local bank
(which in this case is PNB).
PNB employees issued fake LoUs, on the back of which foreign branches of a few
Indian banks โ including Axis and Allahabad Bank โ gave dollar loans to PNB.
These foreign currency loans were used to fund PNBโs NOSTRO accounts and from
these accounts funds moved to certain overseas parties. A โNOSTROโ account is an
account which banks maintain foreign currency stocks in the form of bank accounts
with their overseas branches; these are called NOSTRO accounts.
Based on unauthorized LoUs, the PNB employees misused the SWIFT network to
transmit messages to Allahabad Bank and Axis Bank on fund requirement. In using
SWIFT, one has to log into the network to fill up fields like the account number and
SWIFT code, following which it is endorsed by a supervisor. The process is
completed when the bank receiving the message confirms and the details are
8. validated. While all this was done using SWIFT passwords, the transactions were
never recorded in the bankโs core system โ thus keeping the PNB management in
the dark for a long time.
The other question that crops up is: who were the suppliers? In the closely-knit world
of diamonds, the overseas suppliers of rough stones and the final exporters of
diamonds are often members of the clan, if not same family. According to PNBโs
statement to enforcement agencies, the funds so raised for payment of import bills
have not been utilized for such purposes in many cases.
According to banking circles, PNB will have to make good the lost money even
though technically Allahabad Bank and Axis Bank took the exposure. โIt is not known
whether Axis and Allahabad still have the loans on their books or they have offloaded
some of it to other banks,โ said another banker.
According to a confidential note from PNB to some banks, similar modus operandi
was used by the same officials in companies belonging to Mehul Choksi - promoted
Gitanjali Gems, Gili India and Nakshatra, while issuing LoUs/ LoCs. The transactions
were initially routed through the CBS system but subsequently changes were made
in the LCs by substantially increasing the amount and transmitted through SWIFT
without reporting this to CBS.
According to the note, LoUs were opened for pearl import for which total time period
allowed by RBI is 90 days. Some of the overseas branches of Indian banks
overlooked the rule. PNB has alleged โclear criminal connivanceโ of group
companies of Modi and Gitanjali with some officials of PNB and other banks. In what
could lead to a feud between PNB and other Indian banks, the former has
complained that some of the branches of other Indian banks have not shared key
documents related to the credit with PNB. ..
It appears the overseas buyersโ credit against LoUs was used to retire import bills or
replenish maturing credit.
Allahabad Bank has also issued a confidential note to other banks on the modus
operandi of the fraud.
2.7 Locations of NOSTRO Accounts
9. Most large commercial banks worldwide hold NOSTRO accounts in every country
with a convertible currency. Major examples of convertible currencies are the U.S.
dollar, Canadian dollar, British pound, the European euro and the Japanese yen.
Prior to the advent of the euro as a currency for financial settlements on January 1,
1999, banks needed to hold NOSTRO accounts in all of the countries that now use
the euro. Since that date, one NOSTRO for the entire euro zone has been sufficient.
If a country were to leave the Eurozone, either voluntarily or involuntarily, banks
would need to re-establish NOSTROs in that country in its new currency in order to
continue making payments. The most commonly discussed potential exit from the
euro zone has been Greece, which received multiple bailout packages since the
beginning of the 2008 financial market crisis.
2.8 How did this scam come to light?
It came to light last month, when representatives of Modiโs companies approached
PNB for a fresh loan, PNB said in its complaint, the details of which have been made
public.
By then, Shetty had retired and his successor declined to honour Modiโs request. โAt
this, the firms contested that they have been availing this facility in the past also but
the branch records did not reveal details of any such facility,โ PNB said in the
complaint. This was when it discovered the fake letters of undertaking and filed an
initial complaint alleging a $44 million fraud. Two weeks later, it filed another
complaint covering transactions worth about $1.77 billion ($1,771,690 million),
according to people familiar with the matter. On February 26th
, it reported that the
scam amount could go up by $204 million.
3. WHO BEARS THE BRUNT?
10. PNB is in talks with other banks and liabilities will be decided after the probe, PNB
Chief Executive Officer Sunil Mehta told reporters on Thursday. He added that PNB
will follow the regulatorโs instructions on repayment.
The Reserve Bank of India (RBI) hasnโt responded to emails seeking comment and
hasnโt publicly commented on the case.
PNB has alleged that the money was used either to retire import bills or replenish
maturing lines of credit with some other banks, according to the document seen by
Bloomberg. In its public complaint, PNB names the Hong Kong branches of Axis
Bank Ltd. and Allahabad Bank as the overseas counterparties.
Allahabad Bank has exposure of about Rs 40 billion while Axis Bank has a roughly
Rs 30 billion exposure, a person familiar with the matter told reporters in New Delhi.
Union Bank has about Rs 20 billion exposure with rest accounted to State Bank of
India, the person said, asking not to be named as the information isnโt public.
Axis Bank told the exchanges on Thursday that the transactions were undertaken in
the normal course of business and credited to PNBโs NOSTRO accounts. It added it
has "sold down all of the referred transactions.โ
4. Loose Ends
If the integration between SWIFT and CBS is not smooth, or if it is not done, banks
have to regularly reconcile NOSTRO accounts immediately on receipt of the
statements from the correspondent banks with NOSTRO mirror balances.
According to bankers, most banks receive NOSTRO account statements through
SWIFT MT940 and MT950. Banks without SWIFT get a soft copy of the statement
11. either by email or a hardcopy delivered from the local branch of the correspondent
bank. Reconciliation or can be automated through specialised solutions.
Despite integration, according to the CBI FIR filed by PNB dated February 15th
,
2018, along with unauthorised LoUs amounting to โน3,032 crore, the bank officials
had also issued fraudulent LoCs amounting to โน1,854 crore to the Gitanjali Group of
companies.
The conniving officer issued LoCs by entering a smaller amount in the trade finance
module of the CBS system and generated the reference number; a SWIFT message
was sent for the amount. Subsequently, without making any change in the CBS, the
bank officials sent modified SWIFT messages for an enhanced amount under the
same reference to the beneficiary bank.
The overseas supplier discounted the documents drawn under such LoCs (based on
the SWIFT message) with overseas banks.
As this illustrates, a failure of all control, systems and check can lead to fraud,
irrespective of software systems.
12. 5. CONCLUSION
5.1 What comes next?
Government has asked all banks to send reports involving this case or other such
incidents latest by the end of this week, the PTI reported.
PNBโs CEO said Modi has reached out to PNB to present a repayment plan but the
bank has sought more details. Nirav Modi had left India even before the CBI
complaint was filed, according to media reports that didnโt cite any people.
The Punjab National Bank (PNB) today suspended eight more employees in
connection with โน14,400 crore fraudulent transactions case involving billionaire
jeweller designer Nirav Modi.
The passport issuing authority of the Ministry of External Affairs (MEA) has also
suspended validity of passports of Nirav Modi and his business partner Mehul
Choksi for a period of four weeks.
The Enforcement Directorate today conducted multiple searches in connection with
another โน280 crore money laundering case against Nirav Modi and others following
a complaint by Punjab National Bank, PTI reported. PTI quoted official sources as
saying that the agency sleuths swooped down on at least 10 premises of entities
involved in the case early morning.
On Wednesday, the agencies had seized jewellery, gold and other assets worth
โน6,400 crore linked to Nirav Modi in connection with the PNB fraud case. The ED
had also issued summons to Nirav Modi and Mehul Choksi.
According to sources, Nirav Modi is presently staying in New York along with his wife
Ami. His brother Nishal Modi is believed to be in Belgium.
