Punjab National Bank disclosed in February 2018 that it was the victim of India's largest bank fraud amounting to $1.77 billion. Nirav Modi, a diamond merchant, and his uncle Mehul Choksi defrauded PNB through unauthorized Letters of Undertaking issued by corrupt bank employees over 7 years. The LOUs were issued on SWIFT without being recorded in the bank's core system, allowing Modi to take out loans from foreign banks against the LOUs but use the funds for other purposes. This revealed major failures in PNB's internal controls around reconciliation, auditing, and preventing direct SWIFT access which enabled the large scale fraud.

1. CLASSIC EXAMPLE OF
OPERATIONAL RISK-
CASE STUDY OF PNB RUBY SHARMA

2. BRIEF OF THE CASE
India's second largest state-owned lender Punjab National Bank
disclosed on Feb. 14, 2018 that it was the victim of the country’s
largest bank fraud. PNB revealed that fraudulent transactions by
billionaire jeweller Nirav Modi and related entities amounted to $1.77
billion or over Rs 11,400 crore.
The key accused in the case were jeweller and designer Nirav Modi,
his maternal uncle Mehul Choksi, and other relatives and some PNB
employees.
Nirav Modi and his relatives escaped India in early 2018, days before
the news of the scam became public. PNB scam has been dubbed as
the biggest fraud in India's banking history.
RUBY SHARMA

3. WHO IS NIRAV MODI?
RUBY SHARMA

4. Nirav Modi is a diamond merchant and India's 85th richest person.
According to Forbes, his rank was 57th among the billionaire list of
2017.
He is an elite jewellery designer and his creations have been sported
by high-profile stars including Priyanka Chopra and Kate Winslet, who
wore one at the Academy Awards.
Modi is the Chairman of Firestar International, the parent of the Nirav
Modi chain, which has stores in key markets across the globe.
He has 16 stores in diverse locations such as such as Delhi, Mumbai,
New York, Hong Kong, London and Macau.
He is currently in the United Kingdom and is seeking political asylum
in Britain.
RUBY SHARMA

5. MODUS OPERANDI:
PNB employees issued the fake Letter of Undertakings (LOU)
which could lead to fraud.
The two employees of PNB directly used SWIFT and while doing it,
they did not pay attention on the core banking system (CBS).The FIR
contained the details like those two PNB employees were issuing
LOUs in unauthorized way for 7 years. Afterwards, one of them
retired and the new employee came on his designation.
In January, when the officials of firm demanded fresh LOUs from PNB,
the new PNB officer asked for the collateral security.
The officials of firm mentioned that this had been never asked by the
PNB manager in the last 7 years. Now the bank got signal that
something wrong has taken place.
The new Bank officer got doubt on the past 7 years LOU issuance and
he looked into the concerned matter in detail.
RUBY SHARMA

6. MODUS OPERANDI:
An Indian bank (A) issues an LOU (Letter of undertaking) at the
request of a corporate to a bank in a different country (B),
guaranteeing a loan that (B) gives to a third party who is overseas.
The third party generally is the beneficiary or the importer. The
importer sells the goods and repays the loan. LOUs as corporate
lending product is a common practice by banks in India.
As it is a high risk lending, LOUs are generally issued against
collateral. Regulatory compliance requires the LOU cannot be issued
for more than 90 days.
After detail investigation, it found near about 100 LOUs issued to
these firms without asking for collateral security. PNB became the
victim of the fraud. It faced the problem amounting to about 11,400
crores. The PNB reported to the RBI and CBI.
RUBY SHARMA

7. MODUS OPERANDI:
Modi needed money to import pearls & diamonds. He wanted to have
foreign currency loan and his earning through exporting was in
foreign currency. The most important thing is that he wanted to
borrow without his loan account. Hence, he arranged LOU from the
PNB to get cheap buyer’s credit in foreign currency, which is for a
short term.
Ideally, Modi should have exported the pearls, diamonds & use the
earnings for settling the due amount of LOU as & when demanded by
the bank according to its standard procedure.
Further, PNB need to have paid back the loan it has risen in its
NOSTRO account from the overseas banks.
RUBY SHARMA

8. UNDERSTANDING THE FLOW
OF TRANSACTIONS
SWIFT – the banking message service. It’s like a message written in stone,
effectively that says PNB will pay in case of any default.
Nostro Account – the account that PNB maintains with banks abroad, where the
other bank will send money meant for PNB customers.
Note: The other bank gives money to PNB’s Nostro account. Not to NM. They
don’t know NM. The other banks only know that PNB has given a guarantee on
the SWIFT channel.
RUBY SHARMA

9. MODUS OPERANDI:
But he utilized the money for other purposes without paying it to the
bank.
These activities were happening from last 7 years. Rather Modi used
to pay back the principal & interest on old LOU by new one. The total
LoUs taken by Nirav Modi & Mehul Choksi stood out at 293 according
investigating agencies detail. In this way the cycle of fraud was
repeating.
Among those named is a deputy manager, Gokulnath Shetty, who was
posted at PNBs foreign exchange department in Mumbai since March
31, 2010. He had allegedly along with another official Manoj Kharat
fraudulently issued LoUs to these firms without following prescribed
procedure or making entries in the banking system, avoiding
detection of transactions. RUBY SHARMA

10. THE FLAW:
There was no linkage of SWIFT to CORE system. According to the
FIR, SWIFT messages were issued to Allahabad bank and Axis
Bank in Hongkong.
The SWIFT had bypassed the CBS.
There was no internal coordination and also no proper monitoring
which resulted in operation.
Majorly, the internal banking system was exposed to fraudulent
activities. It is must to use the standard operating system for prompt
and clean banking.
It was the responsibility of external as well as internal auditor to trace
the transaction also contingent liability figure or the other question
arises whether those auditors were also involved or not.
Concurrent auditors whose job is of transaction verification. They
couldn’t notice the case at that time was big question. Hence, all
auditors like concurrent, internal and statutory were failed in finding
out the problem. RUBY SHARMA

11. Q. WHAT WENT WRONG AT
PNB?
ANS. THERE WERE MANY
FAILURES IN INTERNAL
CONTROLS.1. All the years there was the same officer at the LOU desk
The Bank did have a procedure that required an officer to be transferred every 2
to 3 years. It is not known why the person was not shifted.
2. Direct access of SWIFT system
SWIFT provides a network that enables financial institutions worldwide to send
and receive information about financial transactions in a secure, standardized
and reliable environment. (www.swift.com)
The officer gained direct access to SWIFT terminal to send the fraudulent LOUs.
These transactions were not recorded in the Bank’s books. It is surprising that
having straight through processing of SWIFT messages from the core banking
system, any messages directly sent was not tracked as exceptions.
3. Unreconciled Nostro Accounts:
Nostro account refers to an account that a bank holds in a foreign currency in
another bank.
The loans guaranteed pass through PNBs Nostro account. However this control
failed as the accounts were not reconciled on a regular basis.
RUBY SHARMA

12. CONTD….
4. LOU reconciliation not done:
Banks are subject to audit by central bank, internal audit and audit by
external firms. Normally they look for reconciliations and check a few
selected randomly for assurance that the transactions are genuine.
This appears not to be the case.
5. Sharing of passwords:
It is reported that the prime accused in the Bank shared the SWIFT
password with the corporate.
It is still not clear how the overseas banks (Overseas branches of
Indian banks) routinely lent money against LOUs without once doing a
due diligence. More surprising is that these banks are audited as well
by the local controllers and firms. There are no reports of anyone
raising exceptions to such transactions.
Perhaps this will go down as a classic example of operational risk
leading to credit risk.
RUBY SHARMA

13. REFERENCES:
https://www.researchgate.net/publication/335517910_Analyzing_Pu
njab_National_Bank_Scam
https://www.bloombergquint.com/law-and-policy/the-nirav-modi-
pnb-fraud-case-everything-we-know-so-far
https://blog.bahwancybertek.com/a-case-study-on-nirav-modi-
the-punjab-national-bank-fraud/
https://www.finextra.com/blogposting/15061/gem-of-a-fraud-a-
classic-example-of-operational-risk
RUBY SHARMA