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Of Banks and Runners: A New Kind of Marathon?
If there is one term that is unfortunately, increasingly, being associated with banks these days, it is ‘Non Performing Assets’ (NPAs). The term gained traction in the Economic Survey 2015-16 in the ‘Twin Balance Sheet’ (TBS) problem, viz. the rising NPAs in banks and the concurrent rising indebtedness of private sector companies with overleveraged assets.
Due to high debt accumulation, companies are unable to pay interest payments on loans. Consequently, as companies fail to repay their loans or interests, banks are also adversely affected. While the NPA problem has been festering for long in India, the recent unearthing of scams in the range of ₹ 9,000 to 11,000 crore+, has led to shock and outrage across the country. Businesses going bankrupt is one thing, businesses siphoning off funds acquired from loans (often taken in an unauthorized manner) is a different issue altogether. That, perhaps, is the reason for this massive outrage- the sheer moral depravity of the act of ‘robbing’ banks in broad daylight as it were, and the quantum of the fraud in question.
How the Nirav Modi scam unfolded?
On February 14, 2018, just as the local stock markets opened for trading, Punjab National Bank (PNB) informed the stock exchanges that it had detected a fraud of around Rs.11, 400 crore. Soon it became clear that the PNB fraud was engineered by companies of diamond tycoon Nirav Modi, helped along by PNB officials at its Brady House branch in Mumbai. (At the time of writing this piece, Nirav Modi and his family are no longer in India.)
On February 1, 2018, the CBI had registered a case against Modi and some related entities for allegedly cheating PNB of Rs. 280 crore through unauthorized transactions. The bank had said at that time that it was investigating further to see whether there were more such transactions.
According to the bank’s complaint, the PNB fraud surfaced after one of the key accused bank officials retired. When executives from Nirav Modi’s companies came asking for a letter of undertaking (LoU), which is essentially a bank guarantee against which another lender gives a foreign currency loan, the new official in charge demanded the mandatory collateral. The executives insisted they had never given collateral before, which raised a red flag. An internal investigation showed the bank had issued hundreds of unauthorized PNB LoUs on behalf of Nirav Modi and his uncle, Mehul Choksi of Gitanjali Gems Ltd, to foreign branches of Indian lenders. These bank guarantees were to help these firms raise buyer’s credit from these overseas banks to pay for their imports.
PNB’s complaint to the CBI named two bank officials- Gokulnath Shetty, a deputy manager in its foreign exchange department, and Manoj Kharat, who operated the financial messaging system- the Society for Worldwide Interbank Financial Telecommunication (SWIFT). Both have since been arrested. These individuals had allegedly issued LoUs without getting proper approvals and without making entries in the core banking system (CBS), the software used to support a bank’s most common transactions, and which also acts as a record keeper.
According to experts, the unauthorized transactions routed via SWIFT went undetected because it was not linked to CBS and because checks failed at several levels. Normally, when an importer goes to a bank for such a guarantee, the bank asks him for collateral, which could be land or a fixed deposit, and/or the bank sanctions a credit limit after a credit appraisal. Here, neither of these procedures were followed.
Others doing the rounds?
The journalists Debashish Basu and Sucheta Dalal wrote a book called The Scam: From Harshad Mehta to Ketan Parekh. They then revised it with the title ‘Also includes JPC fiasco and Global Trust Bank scam’. As Aakar Patel of Firstpost points out, “I fear they will have to keep revising it because this wretched nation seems to have no shortage of huge banking frauds.”
This scam is not the only one that has shaken banks and public confidence in recent times. The Vijay Mallya episode, albeit something that happened gradually and more or less in plain sight, but stringent action initiated only after he had left the country, is another much-cited one.
Even as the Nirav Modi scam was unfolding, the CBI had registered an FIR against the Kotharis (who run Rotomac Global) for allegedly defaulting on loans taken by Rotomac Global Pvt. Ltd from the consortium of banks from 2008 onwards. The CBI initiated the action on the complaint of Bank of Baroda, a member of the consortium led by Bank of India, which had approached the agency fearing that Vikram Kothari might flee India after billionaire diamantaire Nirav Modi and owner of Gitanjali Gems Mehul Choksi reportedly left India before the registration of a case against them.
Lessons unearthed
- There have to be strict regulation and monitoring frameworks in place within banks, and over banks from the Reserve Bank of India (RBI).
- Banks should be overtly careful about the activities of their employees and monitor them strictly, while also providing incentives of good pay and tokens of appreciation, things which have allegedly been absent/less in public sector banks (PSBs).
- The role of auditors is no less when it comes to the way corporates function. In cases where their financial statements form the basis for assessing their credibility, it becomes important to see whether auditors have acted diligently to catch and report instances of malfeasance in the company accounts.
- It has also emerged that in March 2017, an order issued by the then whole-time member of the Securities and Exchange Board of India (SEBI) found Mehul Choksi, owner of Gitanjali Gems, along with other promoter entities of the company, prima faciein violation of various security market regulations and advised the capital markets regulator to conduct further investigations. The case, however, was not pursued. This points to a need for convergence between various regulating agencies to tap concerns faster and more efficiently.
Conclusion
What’s done is done and knee-jerk reactions like mass calls for privatization of PSBs will no longer suffice. We are living in an age where digitalization can be a bane but it can also be a boon if the system keeps in step with changes (like linking SWIFT and banks’ CBS, for which RBI has set April 30 as the “outer limit”). Moreover, blockchain technology can be harnessed for payment and transaction solutions, maintaining a transparent ledger etc. Recognition and Reform have to be the buzzwords for any palpable change to take place.
