April 07, 2020
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Neglect Is A Fraud’s Best Friend

Regulators didn’t merely fail to crack down on PNB’s violations—they gave it pats on the back.

Neglect Is A Fraud’s Best Friend
Enforcement Directorate officials check documents after a PNB-related raid in Thane
Photograph by PTI
Neglect Is A Fraud’s Best Friend

It is ironic that technology relied on to check malpractices in the financial sector and improve the ease of doing business has again proved to be an easily manipulated tool. Harshad Mehta breached technol­ogy safeguards to milk the banking system 26 years ago, using bank receipts to ­fin­ance his deals. And now, Nirav Modi has taken advantage of loopholes and used letters of undertaking (LoU) iss­ued by Punjab National Bank (PNB) to acquire around Rs 11,400 crore from overseas branches of Indian banks.

The best systems can fail without adequate checks and balances, opine experts. In Modi’s case, safeguards failed in multiple areas. Can the scam be ascribed to a systemic problem in the operation of nostro accounts or a governance issue?  

C.H. Venkatachalam, general secretary of the All India Bank Employees’ Association, calls it a collective failure of multiple levels of control. “Such huge frauds cannot be committed over a period of 6 or 7 years without anyone knowing about it. It is naïve to believe so as, for issuing a LoU, two officials have to be ­involved—one to prepare the document and another to authorise it. Similarly, for Society of Worldwide Interbank Financial Telecommunication (SWIFT) transfers, one officer prepares the message and another higher authority has to sanction the payment,” he says. And when the SWIFT message confirmation is sent by the overseas bank, it’s received by the branch’s chief manager

But in PNB’s case, all this had reportedly been delegated to a junior officer, who unusually had not been transferred from the Mumbai branch of the bank or given any other position in the last several years. What is more ast­ounding is that, in violation of the “maker and checker” concept, this official was given access to secret passwords issued to the higher authorities for sanctioning the transactions. “It is clearly a total failure of the banking system. What is surprising is that the concurrent audit, done on a daily basis, failed to unravel the malpractice. The fraud raises questions on the technology aspects, supervision, monitoring, audit, internal control, etc., besides the role of the Reserve Bank of India in the whole episode,” states Venkatachalam.

In August 2016, the RBI cautioned banks about abusing the SWIFT interbank network for ‘unauthorised transfer of funds’. Yet PNB, which has won ­vigilance excellence awards from the Central Vigilance Commission (CVC), evidently chose to overlook this. The CVC didn’t respond to email queries about its due diligence before conferring awards. Instead, it merely came out with a statement that the awards given to PNB were  for ‘outstanding contribution’ in the category of ‘timely completion of disci­plinary proceedings’.

Diluted Ethics

PNB ex-deputy ­manager Gokulnath Shetty arrested

Photograph by PTI

According to a study led by Assocham, around 65 per cent of the fraud cases reported by banks are technology-related (covering fraud committed through or at an internet banking channel, ATMs and other payment channels like credit/debit/prepaid cards), while advance-rel­ated fraud accounts for 64 per cent of the total amount of money involved.   

E.A.S. Sarma, a former senior bureaucrat and social activist, attributes the PNB fiasco to failure at three levels—­regulators, independent directors and corporate governance. In the case of the regulators— the RBI and the government—the position is compromised by their officials serving as directors of the banks. As for independent directors, a culture of pat­ronage prevails with retired officials being nominated. Such directors usually fail in their crucial role of being critical appraisers of the bank or firm’s decisions. In the case of Gitanjali Gems, a listed company that is among several firms involved in the scam, at no time was any question raised over its financial health or about its practices.

“Most bank NPAs [non-performing assets], around 80 per cent, result from the borrowing companies diverting or siphoning off money. Though an RBI circular suggested a CBI probe in the case of NPAs worth over Rs. 50 crore, ideally forensic experts should be involved, as fraud is often covered up by recasting debts,” says Sarma, pointing to the recasting of Gitanjali Gems’ loan of Rs 4,300 crore in 2015. In fact, in 2013, there was a dissenting note from a former RBI deputy governor on the bank’s ­decision to sanction Rs 1500 crore to Gitanjali despite its failure to clear earlier dues. But PNB ignored it.

Gitanjali Group or Nirav Modi’s companies are but a few among the scores of wilful defaulters in the latest list prepared by the authorities. The list includes several jewellers like Winsome Diamonds, with unpaid dues of Rs 90,037 crore, and Forever Precious Jewellery & Diamonds (Rs. 74,798 crore). If the banks and the regulators fail to act, there will be many more and much bigger scams in the making, given that the potential bad loans already restructured under the corporate debt restructuring (CDR) scheme run into Rs 6 lakh crore.

PNB has won ‘vigilance excellence awards’ from the Central Vigilance Commission (CVC). CVC didn’t respond to queries about its due diligence.

The Rotomac case is just one recent instance that serves to illustrate the ­reluctance of banks to act against defaulting companies, which leads to a situation where the companies and bankers get off scot-free. It is only the consumers who are left asking how safe their savings dep­osits are with the banks.

Ranen Banerjee, partner, PwC India, says scams in the banking sector are not unusual, nor are they restricted to any country. It also doesn’t mean the system is weak. “This is not a systemic failure but a governance failure. We need more checks and balances, stronger processes where employees are concerned and stronger oversight to ensure implementation of rules,” he says. Given that computer systems are operated by humans, a breach in ethics is always a possibility.

India has a far less colourful history of banking fraud than the US or the EU, where such cases are more numerous and on a larger scale. One example of this is America’s subprime mortgage implosion that led to the financial crisis in 2008, points out Prof Charan Singh of IIM-Bangalore, who did a study on banking fraud and stressed assets in the wake of the Kingfisher Airlines scandal. In the PNB case, “you cannot escape the fact that there was oversight at different levels right from the branch to the regional and zonal level. The telltale signs in data flow were missed so there were no checks and balances. The management staff failed to be alert to their subordinates’ behaviour. Additionally, there is a lack of training and ethical behaviour at the managerial level,” says Singh. A former RBI chair professor at IIMB, Singh feels that when bankers are saddled with too much responsibility over and above their regular work, such incidents are more likely to occur than they are in normal times.

The cost of banking frauds unless ­handled with responsibility can have a negative impact on the economy and ­investor sentiments. Given that work ethics have become diluted, the only ­option before the regulator is to fix the system and imp­ose harsh punishment on erring staff right from top to bottom. Else we may see more and more unscrupulous people run off with the till.

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