The Punjab National Bank (PNB) Scam

It gives an overview about the background of Nirav Modi and the facts about the scam he committed. It talks about the impact caused by the scam including the changes brought in the legislation and the legal actions which took place against him. Further, it covers the aftermath of the scam and the current legal position of India.
Estimated Reading Time: 9 minutes

Introduction  

Anything which is gained by deception and illegal means is termed as a scam. Most common of all is the financial scam for example PNB Scam. It is commonly known as the ‘white-collar crimes,’ which is a form of the non-violent offense committed by the people of higher social status. These offenses go unreported in the majority of the cases because it is difficult for the prosecution to detect where the fault lies. There are seven types of financial scams; money laundering, embezzlement, credit and fraud, securities and investment fraud, identity theft and phishing, counterfeiting, and mail fraud.[1] So let us discuss PNB scam.

India is one of the countries that has faced huge economic loss in scams. It has been observed that the scams are done on the public sector undertaking banks, which are government owned financial companies. Even after experiencing the largest money laundering scams by Harshad Mehta, Andimuthu Raja and Vijay Mallya in 1992, 2007 and 2008 respectively, there was another massive financial scam reported in 2018 by Nirav Modi.

Background of PNB

Nirav Modi was born in Palanpur, Gujarat on 27th February 1971 to Deepak Modi and Gita Modi. He married to his college friend named Ami Modi and has three children from her. His father who was a traditional diamond jeweler, moved to Belgium in 1940s to expand his business, since the country is known for diamonds. Following that, his maternal uncle named Mehul Choksi, also engaged into the jewelry business and founded the Gitanjali Group in 1966. While he was still pursuing his studies from Warton Business School, Philadelphia, USA, he left it in middle and came to Mumbai in 1989 to work under his maternal uncle.After gaining an experience of 10 years, he founded his own business named Firestone Diamonds. Later in 2010, he launched a brand of his name.[2] Gradually, his company gained huge success and fame that top celebrities like Priyanka Chopra became its ambassador.He touched the peak of his success when he designed a necklace called the ‘Golconda necklace’ which was sold in auction for Rs. 16.29 crores. In 2017, Forbes magazine declared him as the 57th richest man in India.[3]

Facts of the PNB Scam 

Importing and exporting of diamonds:

Nirav Modi’s business involved importing and exporting of jewels especially diamonds. Basically, there are two ways to do it. The person can either import goods without taking loans from the banks or with taking loans from the banks. For instance, when a business in India wants to buy goods from a foreign country, suppose Hong Kong, then in this case the latter would be the exporter and the former would be importer. If the importermakes the payment in exchange of the goods, without taking help from banks, it would be considered a normal procedure for importing and exporting of goods.

If the importer does not have enough funds to buy goods from exporter, it would end up taking loans from the banks. Since, the payment has to be made in foreign currency, the importer prefers a foreign bank for ‘buyer’s credit,’ so that the foreign bank directly makes the payment to the exporter of the foreign country avoiding the need of currency exchange. It is also advantageous to borrow money from a foreign bank because it offers cheaper interest rates than the local banks.

However, importing and exporting is not a simple process. It is a much complex procedure including various steps. For instance, where two organizations from India and Hong Kong are importer and exporter of diamonds respectively, the following steps would be required;

  1. importerof India makes an order of diamonds,
  2. exporter of Hong Kong sends an invoice along with other documents, after delivering the goods,
  3. importer then transfers the invoice and other documents to a local bank and ask them for a buyer’s credit,
  4. the bank, in return, requires the securities to be deposited by the importer,
  5. accordingly, the importer gives its securities to the bank,
  6. the bankconducts the due diligence of the importer’s companyto check its credit worthiness,
  7. if the bank is satisfied with the importer, it gives a Letter of Undertaking (LOU) to the foreign bank as an assurance that if the importer defaults, the local bank would act as a guarantor to pay the debt with interest,
  8. the foreign bank makes the payment to the exporter on receiving the LOU from the local bank.

This whole procedure of borrowing is termed as a ‘buyer’s credit.’ Itis observed that the major involvement in the process is of the local bank. The importer does not approach the foreign bank directly but with the help of a local bank. The LOU is given to the foreign bank by the local bank against commission from the importer. It cannot take interest because that is only possible in the case of lending.

Swift system and Nostro account:

The interbank communication is done by a system called ‘swift’ which stands for Society for Worldwide Interbank Financial Telecommunications. The exchange of encrypted messages between two banks is done on a medium. This medium is called the swift system.[4]For instance, the Axis Bank and Punjab National Bank (PNB)are Italian and Indian banks respectively. When PNB would give the LOU to the Axis bank, then through swift system the instructions would be given to the Axis bank to give buyer’s credit to the Indian borrower.In other words, swift is the messaging system.

The term ‘nostro’ is a Latin word which means ‘ours.’ In layman’s term, Indian bank having account with a foreign bank is called a Nostro account.[5]When the foreign bank acknowledges the LOU by a local bank and agrees to lend money to the Indian borrower, it transfers the amount to the ‘nostro account’ of the local bank and then the borrower receives money from that account.

Fraud:

The Punjab National Bank (PNB) is India’s second-largest Public Sector Undertaking bank which was founded in 1894. It is headquartered in New Delhi and has a total asset of net worth Rs. 6,66,390. Nirav Modi bribed two senior officials of PNB of the Brady House branch named Gokulnath Shetty and ManojKharat who were in charge of the process of buyer’s credit. He instructed them that whenever he would require buyer’s credit, they would issue a LOU without asking for securities from him.Axis Bank of Hong Kong was the foreign bank.Moreover, Nirav Modi never repaid the loan with interest. But since PNB gave a LOU to the Axis Bank of Hong Kong, ultimately, PNB had to recover the complete debt of Nirav Modi. This scam took place for seven years. Eventually, the LOUs amounted to Rs. 11,000 crores.

Furthermore, whenever a LOU is issued by a local bank, it has to make an entry to the Core Banking System (CBS). In this case, the PNB officials never made an entry into it. So, there was no record about the issuance of LOU for Nirav Modi to the foreign banks. Besides, there is always a link established between swift messages and CBS. However, in PNB’s case, there was no such link established. The two bribed officials were aware of the fact that the entry of LOU has to be done manually instead of the direct entry. They took advantage of this fact and refrained from making an entry. They believed that they would leave no prove of issuance of LOU in the name of Nirav Modi. It prevented the auditors to track their actions and it became difficult to know where the fault lies.[6]

Exposure of the scam:

In 2017,Gokulnath Shetty, who was one of the bribed officials, got retired and a new employee was appointed in his place. When the three companies of Nirav Modi namely, Diamond RUS, Solar Export and Stellar Diamonds, approached the bank for buyer’s credit, the new employee asked for the security deposits before issuing LOU. The companies responded that they have never deposited any securities. After that, the bank employee checked the CBS of the bank, however, did not found no entry of buyer’s credit of his companies.[7]

Consequently, a detailed investigation took place regarding the same and it was exposed that Nirav Modi has scammed the bank.His companies never paid the buyer’s credit liabilities, hence, the PNB was ultimately made liable. Whereas PNB had no source of direct recovery as it had issued LOUs without security deposit.

Allegations:

On 29th January 2018, the PNB filed a case against Nirav Modi and his company to the CBI alleging that they defrauded the bank for Rs. 13,000 crores. There were four main accused in the scam; Nirav Modi, his wife, his brother and his maternal uncle as they were all partners of the company. The two bribed bank employees were also accused. The FIR report stated,[8]

“The public servants committed abuse of official position to cause pecuniary advantage to the companies of Nirav Modi and wrongful loss to Punjab National Bank of Brady House branch”

Both Nirav Modi and his maternal uncle, Mehul Choksi, are considered as the India’s ‘most wanted.’The main allegations imposed on him and his uncle were for the commission of the offence of criminal conspiracy, criminal breach of trust, cheating and dishonesty, corruption and money laundering.[9]

Impact of PNB scam

  1. On the exposition of the scam, Priyanka Chopra cancelled the contract of being an ambassador with Nirav Modi’s company.
  2. PNB’s share price decreased to more than 10%. Share price of Gitanjali Gems company continuously decreased and within three days it has decreased from Rs. 64 to Rs. 37.
  3. The Fugitive Economic Offenders Bill was introduced in the Lok Sabha and later enacted in August 2018. It gives power to the special court to confiscate the properties of the offender who commit the offence amounting to Rs. 100 crores and above.
  4. The Reserve Bank of India (RBI) brought changes to the banking system by scrapping some of the instruments such as Letter of Undertaking (LoU) and Letter of Comfort (LoC).
  5. It became mandatory for all the banks to integrate their Core Banking System (CBS) with the Swift system by making use of high technology.

Legal actions taken

Enforcement Directorate raided at seventeen different places linked to Nirav Modi and seized his assets of worth Rs. 5,100 crores.It also raided twenty different places of Gitanjali Gems company.According to CBI, Nirav Modi along with his family fled from India on 1st January 2018 and was reportedly hiding in London, UK by travelling through a fake passport. Following that, a Red Corner Notice (RNC) was issued by the CBI against the brother of Nirav Modi along with his executives.

On 19th March 2019, a bank clerk in London recognized Nirav Modi and informed the police officials, thereafter, he was arrested and put in prison by the UK police on behalf of the Indian authorities. He applied for bail but the UK court denied him all the time as they did not trust him fornot fleeing away from the country again. Moreover, it was reportedly revealed that he even tried to bribe and kill the prime witness of the scam. In June 2019, Enforcement Directorate (ED) froze four Swiss bank accounts of him which contained Rs. 2,836 crores. On March 2020, ED seized 72 luxurious items from him worth Rs. 229 crores.The UK court has adjourned his trial till September 2020.[10]

Conclusion 

A study was conducted which revealed that in last five years there has been 389 fraud cases in PNB which amounted to Rs. 6,500 crores. In addition to that, Nirav Modi’s scam amounted Rs. 11,000 crores which sums to Rs. 17,500 crores financial loss to the bank. Since, it was PNB is a government owned bank, it means that the ultimate loss through these scams are suffered by the tax payers because it was indirectly their hard-owned money which they paid to government as tax for the welfare of the society but instead Nirav Modi scammed it.

It is observed that it has become a trend of the scammers to fraud the financial institutions especially PSU banks and then flee away to another country. Despite India being one of the poorest countries, it has lost some massive amounts. For instance, the scam of Vijay Mallya was of worth Rs. 9,000 crores andJatin Mehta’s scam amounted to Rs. 6,000 crores.

Also read Harshad Mehta Scam


[1]Robert Roohparver, What is scam and its types?,Infoguard Cyber Security (June 23, 2019), http://www.infoguardsecurity.com/what-is-scam-and-types-of-scam/.

[2]Joshua Freedman, What We Know About Nirav Modi’s US Companies, Rapaport Diamonds (Mar 7, 2018 11:08 AM IST),https://www.diamonds.net/News/NewsItem.aspx?ArticleID=61976&ArticleTitle=What+We+Know+About+Nirav+Modi%E2%80%99s+US+Companies.

[3]Anuradha Chowdhary, Nirav Modi, Forbes (Mar. 7, 2018), https://www.forbes.com/profile/nirav-modi/#3b0315ee4dcc.

[4]Anja Simic, What Is SWIFT and How Does It Work?,Deel (July 26, 2019), https://www.letsdeel.com/blog/what-is-swift.

[5]Ria Singh, Did You Know: What is a Nostro and a Vostro Account? | RBI Grade B 2019 Question, IxamBee (July 31, 2019), https://www.ixambee.com/blog/what-is-a-nostro-and-a-vostro-account.

[6]Rajeev Dubey, Gem of a scam: How Nirav Modi used fake LoUs to defraud PNB of about Rs 11,400 crore, Business Today (Feb. 16, 2018), https://www.businesstoday.in/sectors/banks/nirav-modi-fake-lous-pnb-scam-bank-fraud-rs-11400-crore/story/270764.html.

[7]Khushboo Narayan, Inside the Punjab National Bank fraud: What an LoU is, how case may impact the bank, The Indian Express (Feb. 18, 2018), https://indianexpress.com/article/explained/inside-the-pnb-fraud-what-an-lou-is-how-case-may-impact-the-bank-nirav-modi-5064357/.

[8]IshaDutt, CBI registers DA case against retired PNB official accused in Nirav Modi case, Business Line (Nov. 16, 2018), https://www.thehindubusinessline.com/money-and-banking/cbi-registers-da-case-against-retired-pnb-official-accused-in-nirav-modi-case/article25517698.ece.

[9]Radhika Merwin, LoU funds flowed through Nirav Modi’s American entities, reveals US examiner, Business Line (Aug. 28, 2018), https://www.thehindubusinessline.com/money-and-banking/lou-funds-flowed-through-nirav-modis-american-entities-reveals-us-examiner/article24803618.ece.

[10]Munish Chandra Pandey, Nirav Modi to be lodged in barrack 12 of Mumbai’s Arthur Road Jail, India tells UK court, India Today (May 12, 2020), https://www.indiatoday.in/india/story/nirav-modi-barrack-12-of-mumbai-arthur-road-jail-india-uk-court-1676962-2020-05-12.

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