The arrest of billionaire jeweller Nirav Modi in the $2 billion PNB fraud case represents a milestone in India’s efforts to deal with those attempting to dupe its banking system, say experts. The ₹14,000-crore fraud, which also involved some bank staff, threatened to bring India’s second largest state-run lender to its knees. Punjab National Bank (PNB) had reported a net loss of over ₹12,200 crore in FY18 after the fraud came to light in January 2018.
Having gone unnoticed for several years, the PNB fraud exposed the weak spots in India’s banking regulation and oversight.
Intense regulatory scrutiny by the government, the Reserve Bank of India (RBI) and an expert panel led by Y.H. Malegam appointed by the banking regulator brought these weaknesses to sharp focus. These include failure by state-run banks in management and monitoring of risk as well as its audits, the central bank informed a parliamentary panel led by Congress leader Veerappa Moily that tabled its report in Parliament in August 2018. The central bank also acknowledged certain gaps in its powers to regulate public sector banks.
Gatekeepers, including board members of the bank, auditors and the banking regulator, could not see the fraud happening, just as in the case of the distressed Infrastructure Leasing & Financial Services (IL&FS).
Ved Jain, former president of accounting rule maker Institute of Chartered Accountants of India (ICAI) said if a fraud of the size detected in PNB could take place, there was little assurance that another one cannot happen or has not happened in other banks.
According to RBI, none of the bank’s audit reports brought out the gaps in the processes followed at PNB’s Brady House Branch in Mumbai since 2011. Hence, directors on the board of the bank had no means to be aware of these irregularities as they banked entirely on the information provided by the management.
Nirav Modi’s lawyer Vijay Aggarwal declined to offer comments for this story.
“The board of directors of banks and their risk management committee should be held responsible for the fraud of such magnitude,” said Jain.
PNB maintains the fraud was not the result of a systemic problem. “It was one of the people’s issues and it was happening in one of the branches. The moment this surfaced, we took corrective action. We started filing with the regulatory authority and we started filing with the investigation agencies,” the bank informed parliamentarians.
The increasing number of bank frauds has led to bankers becoming very cautious in making lending decisions, said experts. According to RBI data, over 5,900 bank frauds involving over ₹32,300 crore were reported in 2017-18. Pavan Kumar Vijay, founder of advisory firm Corporate Professionals, said that lenders have become cautious after the fraud. “All banks should come together and work out a standardized process of giving loans,” Vijay said.
PNB is now getting back on its feet. It reported a net profit of ₹246.5 crore in the December quarter of FY19, recovering from three consecutive quarters of loss.
“The development is positive and we are happy about it,” a senior PNB official said after news emerged about Nirav Modi’s arrest in the UK.
The PNB fraud also brought to light serious differences between the finance ministry and RBI about the regulator’s powers. The RBI holds that not all provisions of the Banking Regulation Act, 1937, applies to state-run banks, especially those relating to hiring and firing of chairmen and managing directors of public sector banks as well as in removing other managerial persons from office. The finance ministry, however, maintains that the central bank has adequate supervisory powers, including inspection of banks’ books and examining directors and other officers under oath.
Also, withdrawal of all loan restructuring schemes and a revised framework for resolution announced by the RBI in February 2018 had increased the transparency in the banking sector. Transparent reporting of bad loans and provisioning requirements has lowered the net profits of several state-owned banks in the first half of the current fiscal. Thirteen state-run banks reported a combined net loss of over ₹21,000 crore in the first half of FY19, compared to 11 reporting a combined net loss of over ₹6,800 crore in the same period a year ago, as per official data.