Eyes wide shut: the $1.8 billion Indian bank fraud that
went unnoticed
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[February 19, 2018]
By Krishna N. Das, Aditya Kalra, Devidutta Tripathy and Tom
Lasseter
NEW DELHI/MUMBAI (Reuters) - The Punjab
National Bank branch in south Mumbai sits just down the road from both
the Bombay Stock Exchange and the Reserve Bank of India, at a physical
center of one of the world's fastest growing major economies.
The branch, clad in a stately colonial edifice, is now also at the heart
of a fraud case linked to billionaire jeweler Nirav Modi that has shaken
confidence in a state banking sector that accounts for some 70 percent
of India's banking assets.
It was here, according to accounts from Punjab National Bank <PNBK.NS>
executives and government investigators, that a lone middle-aged
manager, later aided by his young subordinate, engineered fraudulent
transactions totaling about $1.8 billion from 2011 to 2017.
The bank says it is still investigating how they were able to do so and
go undetected for so long. The accounts given by current and former
executives who spoke to Reuters suggest an answer as simple as it is
alarming: no one was paying attention.
The still unraveling story of how the fraud happened - which includes
the alleged misuse of the SWIFT interbank messaging system and
incomplete ledger entries - points to a breakdown in checks and
balances, and standard banking practices, they said.
The apparent failure of anyone to notice the largest fraud in Indian
banking history until this January reveals a "rot" in the state
financial sector that goes beyond one lender, said Santosh Trivedi, who
spent nearly four decades at Punjab National Bank before retiring in
2016 as a senior manager of audit and inspection in the New Delhi head
office.
"Unless this rot is controlled at this stage, to the satisfaction of the
international community, it is dangerous for the Indian system," Trivedi
said.
JEWELER TO THE STARS
Last month, Punjab National Bank, known as PNB, filed an initial
criminal complaint with the country's Central Bureau of Investigation
(CBI) accusing celebrity jeweler Nirav Modi and others of defrauding the
bank and causing it a loss of 2.8 billion Indian rupees (more than $43
million).
The allegations against a man whose diamond creations have draped
Hollywood stars such as Kate Winslet and Dakota Johnson generated a
flurry of coverage across India's TV screens and newspapers. Modi has
not publicly commented on the case. He and his family left the country
in early January, according to Indian officials, and a call on Sunday to
a corporate spokesperson who has handled media for Modi in the past went
unanswered. No charges have been filed against him.
But as more details surfaced about what is alleged to have happened at
the state-run bank, which was founded in 1894, the stakes have gotten
higher.
A review of bank and government documents related to the case - and
interviews with current and former PNB executives, bank auditors and
experts - points to a lack of accountability and standards in the
country's public banking system.
As of last September, those banks held about 87 percent of the Indian
banking system's 9.46 trillion rupees (about $147 billion) of soured
loans that are non-performing, restructured or rolled over.
A preliminary investigation by the nation's tax authority said of the
PNB fraud that "the hit Indian banks would take in the end may well
exceed" $3 billion, according to an internal note seen by Reuters.
"Yes, there is a problem. We have recognized it," bank Chief Executive
Officer Sunil Mehta said during an investor call on Friday. "We are in
the process of fixing it up. We'll see wherever the loopholes are there.
The people-related risk, we are going to mitigate."
But despite that promise of action, one current senior executive at the
bank's headquarters in New Delhi said further problems could not be
ruled out.
"In Indian banks, we don't work under ideal situation," the executive,
who declined to be identified, said during an interview at his office.
"We are in the business of risk, you can't say there won't be road
accidents."
FRAUDULENT GUARANTEES
According to court documents filed on Saturday by the CBI, branch deputy
manager Gokulnath Shetty issued a series of fraudulent Letters of
Undertaking – essentially guarantees sent to other banks so that they
would provide loans to a customer, in this case a group of Indian
jewelry companies.
These letters were sent to overseas branches of banks, thought to be
almost all Indian, that would then lend money to the jewelry firms.
Shetty did so using the bank's SWIFT system to log in with passwords
that allowed him, and in at least some instances a more junior official,
to serve as both the person who sent messages and as the person who
reviewed them for approval, according to court documents and interviews
with bank executives.
"The involvement and connivance of more staff members and outsiders at
this stage cannot be ruled out," said a CBI document submitted to the
court in Mumbai.
Shetty is now in custody and he has not publicly responded to the
allegations. Calls to a cell phone listed for his wife on court
documents were not answered.
Asked about the password sharing, the senior Punjab National Bank
executive said it was not best practice but in the everyday bustle of
Indian banks it happens.
"When you are flooded with customers in the morning, with 101 demands,
you look for shortcuts," he said. "You do somebody else's work, somebody
else does your work. You are not working in an ideal situation."
[to top of second column] |
A man talks on a phone as he walks past a Nirav Modi showroom during
a raid by the Enforcement Directorate, a government agency that
fights financial crime, in New Delhi, India, February 15, 2018.
REUTERS/Adnan Abidi
A second senior executive at the bank's headquarters, who also asked that his
name not be used, echoed that sentiment.
After entering the transactions on SWIFT, the CBI documents said, Shetty – who
worked at the same branch from 2010 to 2017 despite normal bank practices of
regular rotations - did not record them on the bank's internal system.
Because PNB's internal software system was not linked with SWIFT, employees were
expected to manually log SWIFT activity. If that was not done, the transactions
did not show up on the bank's books.
A SWIFT spokeswoman said in a statement last week that the company does not
comment on individual customers.
All together, there were at least 150 such fraudulent Letters of Undertaking
during a seven-year period, according to a CBI official who spoke on the
condition of anonymity.
In addition to detaining Shetty and the junior employee, the CBI has arrested a
man who it described in court documents as both being "aware about the modus
operandi of the entire scams" and serving as a director in "15 to 16 companies
of Nirav Modi Group".
An older brother of the man, Hemant Bhatt, said outside a courtroom on Saturday
that he was innocent and the allegations were the result of a "media trial". The
brother did not give his name.
An uncle of the junior bank employee, Manoj Kharat, told a Reuters reporter
outside the court that his nephew was "just following orders of superiors" and
added "he wasn't aware of what he is doing".
All three are to be held in custody until March 3. No charges have so far been
laid against them.
Police searched the bank's south Mumbai branch on Sunday and have also
questioned five more Punjab National officials, the CBI official said, taking
the total number bank staff who have been questioned so far to 11.
FINANCIAL HIT
A Feb. 12 note seen by Reuters, sent from PNB to other banks and marked
"confidential", said: "None of the transactions were routed through the CBS
system" - the bank's internal network – "thus avoiding early detection of
fraudulent activity."
The Reserve Bank of India did not respond to a request for comment about whether
it had earlier detected any anomalies in Punjab National Bank's operations or
whether it would take additional action in auditing banks.
In a statement late on Friday the central bank called the fraud at PNB "a case
of operational risk arising on account of delinquent behavior by one or more
employees of the bank and failure of internal controls". It also said the
central bank "has already undertaken a supervisory assessment of control systems
in PNB and will take appropriate supervisory action".
The CBI paperwork says the fraudulent Letters of Undertaking are likely to add
up to "the vicinity of" 60 billion rupees, or more than $930 million. Bank
executives say the amount tallied by working back through internal records is
$1.77 billion.
With assets of about $120 billion as of December, according to bank filings, PNB
will be able to cover any associated losses, though it is still a huge hit for a
bank whose stock market value was only $6.1 billion before it revealed details
of the alleged fraud last week. It has since seen $1.4 billion wiped off that
market capitalization.
The mechanics of how the fraud happened, and what it says about the underlying
industry culture, are worrying, said Abizer Diwanji, national leader for
financial services in India at accounting firm Ernst & Young.
"Checks and balances are there in public banks as well but they are not followed
earnestly," said Diwanji, who has tracked India's financial services industry
for more than two decades.
"This is where the discipline, the culture is not there. I always believe that
we don't have the culture to manage risks, even operational risks. PNB is not an
outlier in this."
To control such risks, most private sector banks require branches to route SWIFT
messages through their central offices, Diwanji said. They also usually
integrate their own software systems and SWIFT, meaning that activity such as a
Letter of Undertaking being sent would get automatically recorded.
Neither is the case at PNB or most state-run banks in India, Diwanji said.
Representatives of two of the external audit firms listed on PNB's annual report
for the 2016-17 fiscal year said they could not have known what happened.
"It was off-books, so auditors will not be in a position to detect it," said
Sudesh Punhani, a partner at Chhajed & Doshi.
Asked whether the bank's failure to integrate its software system and SWIFT was
a cause of concern, Neeraj Golas, a partner at R. Devendra Kumar & Associates,
also an external auditor of the bank, said: "True, true - we have to really get
into it and understand what all these things are."
($1 = 64.2400 Indian rupees)
(Reporting by Krishna N. Das, Aditya Kalra, Devidutta Tripathy and Tom Lasseter;
Additional reporting by Abhirup Roy, Rafael Nam and Rajendra Jadhav in Mumbai
and Manoj Kumar in New Delhi; Writing by Tom Lasseter; Editing by Alex
Richardson)
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