Punjab National Bank fraud case: Here are some unanswered questions in Rs 11,400 crore scam

The arrests of Gokulnath Shetty and Manoj Kharat, the former deputy manager and single window manager respectively at Punjab National Bank (PNB), make it sounds like the Rs 11,400 crore bank fraud that was executed using the issuance of fake Letter of Understandings (LoU) to billionaire jewellery maker Nirav Modi was an act of fraud and only that. But one will miss the larger problem if the case is looked at this way. The happenings at PNB are reminiscent of the Winsome Diamonds fraud that took place a few years ago. It raises many questions. To begin with, a fraud of this magnitude can happen only when everybody — including bank officials, auditors of various persuasions and regulators — keep their eyes shut and let the act develop. One of the major points that has come out of this case is that SWIFT platform was not linked to CBS (core banking system), that is why the junior official could put through transactions without them being reflected in branch accounts. [caption id=“attachment_4358349” align=“alignleft” width=“380”]  Representational image. PTI[/caption] This arrangement is flawed since SWIFT and CBS are stand-alone platforms and are not interfaced. There are a number of checks and balances built in to the system to detect unauthorised transactions. These include • In every SWIFT input transaction, at least three officials are involved: Maker, checker and authoriser. A single person cannot authorise any LOU. Then how did this fraud happen? • A daily report is generated by the SWIFT system wherein all incoming and outgoing messages, financial as well as non-financial, are reflected. All financial transactions appearing on this list are ticked/tallied with CBS. What happened to these reports? • All vouchers generated, including those related to contingent liability on account of LOU, in the branch are required to be manually verified with the system generated reports. Did this too fail? • Every Nostro account has a mirror account in the home branch. As per normal banking practice, the credits and debits appearing in the Nostro account are reconciled on a daily basis. Thus, the credits afforded by the LOU discounting banks needed to be checked daily. The absence of a contra contingent liability in the CBS would have shown-up on the very next day, had daily reconciliation been done diligently. • Even if the compromised officials had been inputting unauthorised SWIFT messages, they must have been recovering the commission/fee/charges on such transactions. The appearance of such a huge income without an underlying transaction should have raised red flags as to the source of revenue, and a consequent search would have revealed the fraud. • For transactions conducted until a year ago, at the maturity of LAU, some account (most probably borrower’s) would have been debited to reimburse the overseas bank for the lending made to PNB under various LOUs. It should have raised suspicion as reimbursement was being made without a contra appearing in PNB books. • The movement and build-up of contingent liability volumes of the branch should have been monitored by the branch’s top management and controllers on the basis of weekly/monthly/quarterly reports. • Monthly irregularity reports, that are submitted to controllers, would have definitely shown these outstandings. Did the bank fail to do this? How come none of these checks worked to trigger the PNB fraud?

• As the said fraudulent transactions have been going on for several years, what have the plethora of auditors/inspectors been doing? Typically, the branch is subjected to concurrent audit, quarterly statutory audit by external auditors (reputed chartered accountancy firms) appointed by the RBI, periodic internal audit by HO auditors/inspectors, RBI Audit under Section 35 and FEMA Audit. None of these could point out the irregularity. Irrespective of whether transactions at PNB was an act of fraud or irregularity, bank’s liabilities towards counter-party banks is absolute and it will have to make good the loss. As is evident, the said fraudulent transactions could have been detected at any stage by following the laid down systems and procedures. But apparently the safeguards built in the system had been neglected. It seems that entire hierarchy was in the know of the developments and exposures were taken with their tacit concurrence. A low-level officer cannot indulge in such voluminous transactions without go ahead from the higher-ups, who could anyway have checked the subordinates at any point of time as all transactional information was available on the tap. The bottomline is this: There are many unanswered questions in the Rs 11,400 crore PNB fraud case. The role of regulator and auditors that helped the fraud to happen needs to be probed in detail. The arrest of one or two middle-level employees would be akin to treating the symptoms of disease and failing to notice the deeper rot. The author is a former executive with SBI