State-owned lender Punjab National Bank (PNB) has informed the Bombay Stock Exchange that it has detected fraudulent transactions worth $ 1,771.7 million (over Rs 11,000 crore) in its mid-corporate branch at Brady House, South Mumbai. PNB has alleged that two employees had “fraudulently issued Letters of Undertaking (LoUs) and transmitted SWIFT instructions to the overseas branches of Indian Banks” to raise buyers credit for companies of billionaire diamond jeweller Nirav Modi without “making entries in the bank system”.
PNB has already suspended at least 10 employees in connection with the alleged crime. However, the bank has not specified if the alleged fraudulent LoUs were backed by collateral/cash margins, or the quantum of liability that the bank faces against the LoUs.
So, what is an LoU, and how is it issued?
An LoU is an assurance given by one bank to another to meet a liability on behalf of a customer. The LoU is akin to a letter of credit or a guarantee. LoUs are used in international banking transactions. An LoU is issued for overseas import remittances and involves four parties — an issuing bank, a receiving bank, an importer and a beneficiary entity overseas. According to norms, the term of an LoU is 180 days, and can be rolled over once for six months. Since LoUs are a form of lending, they are typically backed by security.
LoUs are conveyed from bank to bank through Society for Worldwide Interbank Financial Telecommunication (SWIFT) instructions, which pass through a triple layer of checks. A SWIFT instruction, which represents a bank’s consent, is cleared by a maker, a checker and a verifier before it is sent across. There is no reported instance so far of a breach in SWIFT instructions anywhere in the world.
What are the specific allegations by PNB in the present case?
PNB has alleged that two of its employees “fraudulently” issued LoUs and “transmitted SWIFT instructions to the overseas branches of Indian Banks” to raise buyers’ credit for Nirav Modi’s firms, Diamond R US, Solar Exports, and Stellar Diamonds, without making entries in the bank system
The bank has alleged that one such fraudulent LoU issuance took place on January 16, 2018, for and on behalf of Modi’s firms, which allegedly presented a set of import documents to the branch, with a request to allow buyers’ credit for making payments to suppliers overseas. When bank officials requested the firms to furnish 100% cash margin for the LoU, the firms argued that they had availed this facility in the past as well.
However, branch records did not have the details of any such facility having been granted to the firms. An internal probe by the bank then found that a few of its employees had fraudulently issued LoUs for Hong Kong branches of two Indian banks for and on behalf of Modi’s firms. PNB has alleged that the buyers’ credit based on the fake LOUs may also have been paid through a Nostro account — which is an account that a bank holds in a foreign currency in another bank.
Will the alleged fraud impact the banks that have lent money against the PNB LoUs?
According to PNB’s complaint to CBI, the LoUs were issued for the Hong Kong branches of Allahabad Bank and Axis Bank which have given money to the beneficiary entity on behalf of Modi’s firms. As a result, PNB will have to settle the LoUs with these branches according to the norms of the Hong Kong Monetary Authority.
And how will the fraud impact PNB?
While the quantum of PNB’s liability in the case is not known, market sentiment has already been impacted. The PNB stock fell 9.81% on Wednesday to close at Rs 145.80 per share, and investors lost over Rs 3,000 crore in a single day.
The bank may have to set aside higher provisioning in the next few quarters if it unable to recover the money from the accused firms.
The fraud has been unearthed at a time when Indian banks are reeling under a pile of stressed assets of about Rs 10 lakh crore. Most public sector banks, including the biggest lender, State Bank of India, have posted significant losses for the quarter ended December 31, 2017, due to higher provisioning and a rise in bond yields.