What Punjab National Bank's CEO Sunil Mehta had called a "small turmoil" two months ago has blown into a nightmare of epic proportions for the bank. The $2 billion fraud perpetuated by diamantaire Nirav Modi led to PNB posting the biggest quarterly loss in India's banking history last month. Making matters worse, the bank's own internal probe has reportedly revealed that the lapses that caused the drawn-out fraud go far beyond a few rogue employees.
According to Reuters, a 162-page internal report, produced by four senior PNB officials tasked with probing the fraud, lays out how failings by 54 PNB officials allowed the fraud to be perpetrated. These officials range from clerks to foreign exchange managers, and auditors to heads of regional offices, and eight among them have already been charged by the Central Bureau of Investigation (CBI) for the roles they played.
Significantly, the report revealed that one of the reasons the fraud escaped detection for around seven years was because of lapses within some of the bank's critical areas at its New Delhi headquarters, such as its credit review and international banking units. "There was enough evidence to suggest failures," said the report, adding, "It was observed that blatant system violations/unethical practices/dereliction of responsibilities led bank to such a catastrophe."
Earlier this year, PNB discovered that some officials at its Brady House branch in Mumbai, including former deputy manager Gokulnath Shetty, repeatedly issued fraudulent Letters of Undertaking (LoU) worth Rs 6,498 crore to Modi's companies without following the processes and without securing collateral. A LoU is a guarantee by the issuing bank to the receiving bank and the companies that it would undertake to pay a certain amount of money on a specific date. Using those guarantees, companies controlled by Modi and his uncle Mehul Choksi received credit from banks overseas to fraudulently fund their businesses, PNB alleged.
The reason the scam escaped detection for so long is that Shetty issued the guarantees by using a messaging system called SWIFT, without recording the transactions in the bank's core banking software - something he was supposed to do since the two systems were not integrated. Between March 2011 and May 2017, when he retired, Shetty authorized more than 1200 fraudulent LoUs, the probe found.
It also revealed that the bank's international banking department and the IT division had delayed the integration work. They had also not complied with central bank advisories in 2016 calling for a comprehensive audit of SWIFT systems in use.
Indeed, a recent CBI chargesheet accused the bank's former MD and CEO Usha Ananthasubramanian and her top officials of failing to prevent the fraud despite having prior knowledge of how LoUs can be used to cheat banks. That's because Ananthasubramanian was heading PNB when Indian Overseas Bank (IOB), Chandigarh, reported a LoU fraud in 2016 with a similar modus operandi to the PNB fraud. The RBI had then issued various guidelines and circulars, including about integrating the systems, in order to prevent a repeat. However, PNB allegedly failed to implement them in entirety.
In addition, the PNB investigators said that the fraud could have been detected had the branch followed internal rules and conducted the basic daily SWIFT reconciliation that required logs of transactions on the global payments network to be manually checked against the bank's internal system. "Only one activity would have nailed the whole act at the incipient stage," said the probe report, adding that it was it is "incomprehensible" that the branch staff did not notice the fraud being committed.
The probe found several other problems at the branch. As a mid-level employee, Shetty should have been able to approve transactions of up to Rs 25 lakh, without sign-off from more senior officials. But he had been given unlimited approval powers, the PNB investigators said, without explaining how this happened.
Then, shortly before his retirement, Shetty used his personal Yahoo e-mail address to send 22 e-mails to reconcile large forex transactions involving the Modi group. The use of personal e-mail was "overlooked" by the bank's treasury department, the report said.
It added that under PNB policy, no officer should remain in the same office for more than three years, but Shetty retired after serving in Brady House for seven years. Three transfer orders were issued for him during his tenure, but he was never moved.
Signs that audit practices at Brady House were weak were, in fact, flagged by the branch itself, according to two internal PNB memos reviewed by Reuters. In March 2012, the branch had flagged off that nearly 50% of the observations posed in its annual inspection report - mainly auditor queries - remained "un-replied/unattended to by respective concerned officers", calling it a "critical situation". Then, four years later, the branch's assistant general manager issued an internal memo saying around 18 observations - including five described as zero-tolerance level issues - were pending. This memo was signed by 10 bank officers, including Shetty.
Damningly, such lapses were not limited to the Brady House branch. According to the agency, protocol dictates that the daily reconciliation reports should travel up the chain to PNB's headquarters in New Delhi. Along the way, they would be signed off by the Brady House branch head and sent each month to a Mumbai city regional office that would issue all-clear certificates for the branches it controls.
But the probe report revealed that despite receiving just two monthly reports from the Brady House branch last year instead of 12, the regional office signed off on a "false" compliance certificate, signalling a clean bill of health for the branch. Moreover, despite a massive missing paper trail, none of the senior inspection officers - who conducted 10 visits between 2010 and 2017 to the branch - reported anything "adverse".
Here's another red-flag missed by the Mumbai city regional office that the probe report highlighted. The Brady House branch's import and export transactions in the 12 months to March 2017 stood at $3.3 billion, 50% higher than recorded two years prior thanks to the dealings with Modi & Co. "The exceptional growth should have been noticed," the report said.
According to the agency, this probe report, along with dozens of pages of annexed bank records and internal e-mails, was presented by PNB officials to the bank's fraud risk management arm on April 5. It is also part of the evidence submitted by the CBI in court but the report's findings are being made public only now.
Ironically, the damning conclusions of the report stand in contrast to the lack of regulatory action taken by the authorities since the fraud was reported. No penalty has been imposed on PNB as a result of the fraud and there has been no senior management shake-up.(With agency inputs)