Does PNB itself risk being marked an NPA?

The fraudulent letters of undertaking (LoU) issued by employees at one of Punjab National Bank’s Mumbai branches could create an unprecedented situation in the banking sector whereby counterparty banks may have to mark the bank itself as a non-performing asset in their books if the latter does not honour the LoU-based transactions before March-end.

If this happens, bankers caution that it could undermine the confidence of Indian as well as overseas banks in documentary credits such as LoUs (which PNB issued in favour of banks in Hong Kong so that its Indian customer’s overseas suppliers could be paid) originating from the country. And this could have implications for India’s exports and imports. “If PNB doesn’t pay us before March-end 2018, we may have to make provisions. This (LoUs) is an exposure of banks’ on PNB. So, if the payment doesn’t come through, technically, we will have to treat PNB as NPA,” said a top banker and added that the government and the RBI are unlikely to let this to happen.

The exposure of banks, including Allahabad Bank, Axis Bank, State Bank of India, Union Bank of India, and UCO Bank, to the LoUs, which is akin to a guarantee, issued by PNB is about ₹11,400 crore.

In its criminal complaint to CBI, PNB said two officials at its Brady House branch (Mumbai) had fraudulently issued LoUs for and on behalf of a set of partnership firms — Diamond R US, Solar Exports, and Stellar Diamonds — without following the prescribed procedure. The bank said these firms had Nirav Modi, Nishal Modi, Ami Nirav Modi, and Mehul Chinubhai Chokshi as partners.

These officials obtained required request applications, documents and approval of the authorities thereto and did not make entries in the bank’s system, thereby avoiding detection of the transactions.

They transmitted SWIFT (Society for Worldwide Interbank Financial Telecommunication, which is a global financial messaging platform) instructions to the overseas branches of Indian Banks for raising buyers’ credit and funding PNB’s Nostro accounts (in this case PNB’s account with Hong Kong-based banks).

In its complaint, PNB said “the funds so raised for payment of import bills have not been utilised for such purposes in many cases.”

At a recent meeting of bankers’ to resolve the LoU issue, PNB tried to shift the responsibility for the fraud to counterparty banks by emphasising that their overseas branches had overlooked the fact that LoUs were opened in their favour for import of pearls for a period of one year when as per RBI guidelines the total time period allowed is 90 days from the date of shipment.

To this, a top banker countered: “The goods involved in the transaction did not come under the 90-day restriction. So, the point they were harping on was not right….

“We understand what they are going through. But then they should understand that the whole system will crumble because of their action….For a healthy financial system, honouring these commitments (arising from documentary credit) is very important.”

Nostro account monitoring

Bankers’ underscored that even if the LoUs were not registered in the core banking system, PNB’s treasury and international division at the central office would have definitely known about the millions of dollars worth of transactions happening in its Nostro account (that is PNB’s account with Hong Kong-based banks).

According to another top banker: “We (counterparty banks) could have been more careful. I am not denying that. But then LoU transactions on SWIFT is an accepted business practise.

“The whole financial system works on the understanding that once a LoU is issued, it will be honoured by the counterparty bank….If LoU is issued by a large bank such as PNB, naturally, it will be honoured.”

With bankers not being able to resolve the LoU issue bilaterally, the ball is now the in government and RBI’s court.

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