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The Punjab National

Bank Scam Explained

“This fraud is a combination of complicity and lack of alertness. Simple
practice of checking SWIFT messages could have averted it,”
- Former Executive Director, Bank of Baroda

Finance Discussion Group, IIT Kanpur

Magnitude of the Scam
$1.77 Billion and counting
One third of the 8 times the annual Twice the
market profit realised by recapitalisation
capitalisation of the bank in FY17 amount financed
Are you sure the fraud did
not exceed Rs 11,000 crore ?
“I don’t think so but we are still
investigating” - PNB MD & CEO
Nirav Modi
Diamantaire & India’s 85th richest person

Elite Jewelry designer

Dropped out of Wharton Business School

Firestar Diamond valued $2.3 Billion

Owns jewelry boutique across 3

The Scam
➔ Biggest scam ever detected by an Indian Bank ➔ The scam remained undetected for the past 7
years (2011-2018)

➔ PSB’s are already being recapitalised by the ➔ PNB (Second largest PSB) discovered
Government due to bad loans (INR 10 Trillion) fraudulent transactions worth $1.77 Billion
arising from a single branch

➔ Initially reported as INR 280 crores which on ➔ Additional exposure of $145 Million (INR 9.2
investigation grew to INR 11,300 crores Billion) uncovered by PNB yesterday (March 13)
Letter of Undertaking, a type of bank Society of Worldwide Interbank Financial
guarantee which allows its customer to raise Telecommunications
money from an overseas bank for short term Message of credit transfer upon issuance of
credit. Notifications about LoU’s are LoU is conveyed through the SWIFT system
transferred through SWIFT.
➔ 3 Layers of Security
➔ Need for LoU Maker | Checker | Verifier

➔ Why foreign currency loan ➔ CBS Integration

Integration of SWIFT with bank’s
➔ Guidelines for issuance central software is essential to prevent
such frauds
Simplified Flow of Money

Important Points
Domestic Bank Overseas Bank Business need money to
finance purchases

International lending
rates are lower

Funds raised from an

overseas bank is used to
finance purchases

Overseas bank need a

Buyer Seller
guarantee to loan funds
therefore demands a
Flow of Funds

Important Points
Domestic Bank Overseas Bank
Buyer contacts his
domestic bank for a LoU

Bank issues a LoU based

Cash Margin on a approved line of
or credit or cash margin
Line of Credit
Bank also needs to
record this issuance into
its Core Banking System
Buyer Seller
Flow of Funds

Money Transfer Important Points

Domestic Bank Overseas Bank Money is transferred to
domestic bank’s nostro
account against a LoU

Nostro account is
Money U domestic bank’s account
Transfer Lo in an overseas bank
(foreign currency

Money Transfer Bank transfers money to

buyer who uses this
Buyer Seller
funds for purchases
Flow of Funds

Money Transfer Important Points

Domestic Bank Overseas Bank As the loan period ends,
domestic bank transfers
the principal along with
interest to overseas bank

Money Transfer Funds are recovered

(Line of Credit Case) from buyer ( in case cash
margin is not deposited )

Buyer Seller
Timeline of the Fraud
2011 August 2016
RBI sends a circular to all Indian lenders, advising
PNB employee allegedly starts
them to make sure their internal software, core
providing fraudulent letters of
banking solution or CBS, is properly integrated
understanding to Modi and his
with Swift

2011 2016

February 2016 November 2016

Hackers make off with $81 million by RBI issues stronger circular, citing
sending fake messages through the ‘decentralized’ operations that hinder
Bangladesh Bank’s SWIFT interbank compliance and a ‘high number’ of
messaging system SWIFT user IDs at banks that
increased the risk of misuse,
Timeline of the Fraud
May 2017 Jan 25, 2018 Feb 14, 2018
PNB employee who was allegedly PNB says it found first PNB discloses $1.8
colluding with Modi retires evidence of fraud. billion fraud.

2017 2018

Jan 16, 2018 Jan 29, 2018

PNB alleges that billionaire jeweler PNB submits report on fraud to RBI
Nirav Modi’s associates sought fresh and files complaint with federal
funds from PNB (PNB begins digging investigators
into transaction history)
The Modus Operandi
M/s Diamonds R US, M/s Solar Exports, M/s
Stellar Diamonds approaches PNB for Buyer’s

PNB Staff issues LoU’s without assessing the

creditworthiness or a collateral, records are not
reflected in Core Banking System

Nirav Modi’s firms would refinance the loans by getting their

accomplice at PNB to issue fresh LoUs, borrow money from
one bank and use it to repay the loan of another bank
Who is liable to pay ?
Who to blame ?
Technology Gaps Operational Gaps Regulatory Gaps
Usage of SWIFT No sanctioned credit limits Concurrent audit guidelines

Linkage of CBS with SWIFT Foreign banks rely on credit No reporting on

assessment of domestic contingency credits to RBI
counterparts till January 2018
Inefficient Auditing
Fraud Aftermath
➔ RBI discontinues issuance of Letter of Undertakings

➔ PNB loses 40% of market capitalisation in 10 trading sessions

➔ Trade Finance takes a hit, businesses relying on imports suffer as premiums soar
The drama
The Irony
Is Nirav Modi still a billionaire ?
A look into forex markets
Banks reluctance to issue LoU and
Letter of credits have crashed one
year forward market

Importer are buying dollars in the

spot market to honour their trade
Question of the hour

Tax liability of the bank will depend on how the INR 129 billion
LoUs are reflected in the bank books
That’s all folks !
Finance Discussion Group, IIT Kanpur

Anish Lamba | Simrat Singh

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