Open Access Research Article
BANK FRAUDS IN INDIA IN LIGHT OF THE NIRAV MODI CASE: HOW HAVE THE LAWS CHANGED?
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BANK FRAUDS IN INDIA IN LIGHT OF
THE NIRAV MODI CASE: HOW HAVE THE LAWS CHANGED?
Authored By-
Aakansha Mewar
Introduction
Banks have played an extremely integral part in a man’s life. Since the
nationalization of banks in 1969 and the liberalization of the economy in 1991,
the banking sector has grown immensely and rightly so because it is the one
stop shop for all financial needs such as that of receiving deposits and making
loans. They also provide financial services like wealth management, currency
exchange, and safe deposit boxes. There are several different kinds of banks
including retail banks, commercial or corporate banks, and investment banks.
Considering the fact that banks lead such a fast pace life handling and dealing
with money and despite having a well-regulated system, the structure of such an
organization is a laden with faults that are used to the advantage of some
leading to frauds. The Indian Contract Act, 1872 defines fraud as any
act that an individual undertakes either by himself or through his agent, with
the intent to deceive another party. In the case of a banking fraud, an
individual or his company thereto, performs acts that result in fraudulent
activity by obtaining money illegally from the bank either through false statements
or because of the greed of an authority who works at the bank. The Reserve Bank
of India defines the same as “any behaviour by which one person intends to
gain a dishonest advantage over another”. The Indian Penal Code, 1860,
although does not define fraud directly, it does have provisions for providing
punishments for acts that lead to fraud. For all acts that result in a bank
fraud it is essential for there to be:
a.
An active involvement of the
staff,
b.
Failure to follow the
instructions and guidelines of the bank by the staff,
c.
Collusion between
businessmen, executives, politicians to bend the rules and regulations and any
other external factors.[1]
Further, under S. 65(1) of The Insolvency and Bankruptcy Code, 2016 deals
with provisions in relation with the penalty for fraudulent or malicious
intention of proceedings by an adjudicating officer if the applicant initiates
a Corporate Insolvency Resolution Process (CIRP) either fraudulently or
maliciously with anything other than the resolution of insolvency.
Objectives of the Study
The following are the objectives of this study:
·
To highlight the PNB Scam by
describing the chain of events and their aftermath.
·
To shed light on how the
laws have changed since the scam.
What was the Punjab National Bank Fraud?
On February 14th, 2018, Punjab National Bank declared that at
one of its Mumbai Branches, an embezzlement of around Rs. 11,400 Crores had
taken place. The key accused in the case were Nirav Modi, his maternal uncle,
Mehul Choksi, along with other relatives and some of the PNB employees.
Who was Nirav Modi and How did the Scam unfold?
Nirav Modi was one of the most affluent businessmen in India, having made
it to the 57th spot of the Forbes Billionaires list in 2017. He was
seen as a prominent luxury diamond jeweller and designer as well as the founder
of the Nirav Modi chain of diamond jewellery retail stores having 16 stores
national and international stores all over the world. He made his way into the
business by starting its parent company which was Firestar International of
which he was the Chairman which also had stores internationally.
On 29 January 2018, PNB lodged a FIR with CBI stating that fraudulent
LoUs worth Rs 2.8 billion (Rs 280.7 crore) were first issued on 16 January. In
the complaint, PNB had named three diamond firms, Diamonds R Us, Solar Exports
and Stellar Diamonds. As of 18 May 2018, the scam has ballooned to over Rs
14,000 crore.[2]
How did the scam take place?
The banking sector relies on what is known as a Letter of Undertaking
(hereinafter referred to as LoU) which are essentially a form of guarantee that
is issues by a bank in lieu of the individual/company to attain money from a
foreign branch of an Indian Bank. In the Nirav Modi Case, PNB issued a total of
1212 fraudulent LoUs for over 6 years. The process of this was such that all guidelines
for the issuance of such an Undertaking was completely ignored by overseas
branches of Indian Banks as they failed to share any documentation or
information with PNB which were made available to them by the firms at the time
of availing credit from them. The scam was made possible by the accused in the
form of foreign shelf companies with the intention of embezzling through them.
These shelf companies were found to be present and receiving fraudulent PNB
LoUs in the British Virgin Islands, and other “tax havens” as uncovered by the
Enforcement Directorate.
What went wrong on the part of the Punjab National
Bank?
The following were the mistake made by PNB:
i.
Basic Procedure was not
followed: When a trade financial company approaches a bank for money, the bank
sets a fixed credit limit and does so by initiating a LoU which is then sent to
a lending bank. In the cases of magnitude like that Nirav Modi and Mehul
Choksi, the cases are to be vetted by officials at a higher authority in the
issuing bank. This was seen as a missing step on the part of PNB in the
aforementioned case.
ii.
The rule requiring the
vetting of such procedures by three high officials was replaced for one in the
case: When LoUs are sent to foreign banks for the process of money procurement,
the documents of the same are to be vetted by 3 high authority officials and
are required to log into the system using their ids and passwords. However,
this was ignored in the Nirav Modi and Mehul Choksi case and PNB had admitted
to the mistake on its part stating that the same was verified by an official at
a lower rank and who had acted in two capacities.
iii.
Discrepancy in the process:
the PNB Officials are usually to follow the core banking system which records
all transactions of a high amount, this particular case however, the managerial
official of the bank responsible for forging LoUs, had delinked the Core
Banking System thereby having no record of these transactions.
iv.
PNBs ignorance: The IT Department plays an
integral role in the process as they are responsible for checking that the
Controlled Banking System-SWIFT functions smoothly and properly. What it failed
to notice were the absent LoUs in the present case for over 6 years. Further,
this was not detected by the Vigilance Department, external auditors or the PNB
fraud management committee.
v.
The foreign bank that
provides the loan against these LoUs by the issuing bank, writes to the
controlling office of the issuing bank to confirm the LoU which the Punjab
National Bank claimed to never have received.
How did the fraud come to light?
The LoUs for the Nirav Modi firms were handled by 2 junior employees of
the Punjab National Bank who had been sending out unauthorised Letters of
Undertakings for over 6 years. Upon the retirement of an employee, a new
employee had been hired in his place, and was made responsible for the LoUs in
relation to Nirav Modi. When a fresh guarantee was asked for the same, the new
PNB employee as per protocol asked about the collateral in place of the Firm
which ultimately resulted in an investigation after he was informed that a
collateral had never been asked for in the past from the Nirav Modi Firms.
RBIs Reforms for Banks post the Nirav Modi Fraud Case
Post the Nirav Modi Case, the RBI with immediate effect on March 13th,
2018, barred the issuance of Letters of Undertakings as well as Letters of
Controls to prevent any further misuse of the facility. All Commercial Banks’
LoUs having trade related credits for imports in India, under this directive
were asked to discontinue the same.
Further, the RBI also directed the banks to connect their Core Banking
Systems to the SWIFT (Society for Worldwide Interbank Financial
Telecommunications) System by April 30th 2019. Nirav Modi having
charges of criminal conspiracy, cheating, dishonesty, fraud, breach of trust
and breach of contract has been arrested in London after an arrest warrant was
released against him. As per economic times report, shares of Punjab National
Bank jumped 4 per cent after scam accused Nirav Modi was arrested in London.[3]
RBIs Reforms in the Aftermath of Recurring Bank Frauds
In the last three years, India has seen 22,864 bank fraud cases with an
embezzled amount of Rs. 3.95 trillion. The startling number of bank frauds
brought to the forefront that the guidelines as set had not been quite
effective. The RBI published its annual report for 2020-21 which disclosed not
only the astonishing number of bank frauds but also brought to the limelight
the repercussions of poor Corporate Governance. It highlighted that not only
had low officials in the banks been a part of a fraud but also officials having
high posts in the banks. Due to these reasons, the RBI looked into bettering
the Corporate Governance in the Banking Sector.
On June 11th, 2020, the RBI published a discussion paper on
governance of commercial banks which depend on the recommendations made by the
Basel Committee on Banking Supervision, the guidelines from the RBI Circular of
March 1992 on Do’s and Don’ts for Directors, the provisions of the Securities
and Exchange Board of India (Listing Obligations and Disclosure Requirements)
Regulations, 2015 (Listing Regulations) and the Companies Act, 2013, and other
RBI circulars. On 26 April 2021, RBI issued a circular on 'Corporate Governance
in Banks – Appointment of Directors and Constitution of Committees of the
Board' (Circular) which aims to bolster the governance regime of the banking
sector in India.[4]
The Circular pushes revision of provisions related to appointment of a
bank’s chairperson, tenure of directors, and constitution of committees in
relation to private sector banks, small finance banks and wholly owned
subsidiaries of foreign banks. These however do not apply to the foreign
subsidiaries of the bank. The Circular would only apply to
nationalized banks to the extent it is not inconsistent with provisions of the
specific laws applicable to the nationalized bank. Under the State Bank of
India Act, 1955, (SBI Act), the directors of State Bank of India (other than
managing director) can hold office for up to three years with an option of
reappointment and a cap of six years on holding the office without a break. In
this instance, the provision under the SBI Act is more protective for
stakeholders than the Circular. As the provision with respect to appointment
term of directors (other than managing director) under the Circular and the SBI
Act are inconsistent, the provision of the SBI Act will continue to apply to
the State Bank of India.[5]
CONCLUSION
The Punjab National Bank in relation to the Nirav Modi Case is the
biggest bank fraud that India has ever seen with an estimate of Rs. 14,000 crores
in stollen funds. This case was a turning point in the eyes of banking law and
revealed the loopholes that the laws contained which allowed such frauds to
take place. The alarming amount of money embezzled opened the eyes of the
respective law makers to come up with a more airtight statutes that will result
in fewer bank frauds. In light of the Nirav Modi Case, India saw a vast
realization upon which there have been several amendments in laws and a more
conscious effort to prevent the same on the part of the banks. The PNB cam
exposed several banks to credit risk which need to be examined with regards to
how the process got diluted and how the employees collusion with the client
leading to such a massive fraud could go unnoticed for so long. These resulted
in the changes of the appointment, tenure and constitution changes in bank
employees in the managerial sector.
BIBLIOGRAPHY
References:
1.
Vaneeta Patnaik,
Socio-Economic Offences (ePathshala)
2.
‘What is PNB Scam: PNB Fraud
Case: Nirav Modi Case’ (Business Standard)
accessed 28th
October 2021
3.
Amrish Dogra and Manu Dogra,
‘Sustainability and Ethical Banking: A Case Study of Punjab National Bank’
[2019] 4(1) Amity Journal of Corporate Governance
accessed on 29
October 2021
4.
Souvik Ganguly, Saumya
Sharma and Altamash Qureshi, ‘RBI pushes for Massive Governance Reforms of
Banks in the Aftermath of Recurring Bank Frauds’ (Mondaq, 17 August 2021)
accessed on 30 October 2021
5.
Sushil Pande and Ved
Prakash, ‘Case Study on scam in Indian Banking Industry (Nirav Modi)’ (Paramana
Research)
accessed on 28 October 2021
6.
Feroz Dubash, Sonali
Mahapatra and Shruti Zota, ‘A structured guide to Banking Regulation in India’
(Lexology)
accessed 29 October 2021
7.
Radhika Merwin, ‘PNB Scam:
How a system was gamed’ (The Hindu Business Line, 13 September 2019)
accessed on 30 October 2020
Article Information
BANK FRAUDS IN INDIA IN LIGHT OF THE NIRAV MODI CASE: HOW HAVE THE LAWS CHANGED?
Authors: Aakansha Mewar
- Journal IJLRA
- ISSN 2582-6433
- Published 2023/03/11
- Volume 2
- Issue 7
About Journal
International Journal for Legal Research and Analysis
- Abbreviation IJLRA
- ISSN 2582-6433
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