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What did Nirav Modi whisper to Gokulnath Shetty? “I LOU!” What did the banker tell the robber at gun-point? “I LOU!”
No, there aren’t cheesy love messages, but popular memes around the massive crore scam that has hit India’s second largest public sector bank — Punjab National Bank. Nirav Modi, the Indian billionaire jeweller has allegedly defrauded Punjab National Bank of $1.77 billion (₹11,400 crore), with the help of conniving bank officials with Gokulnath Shetty, deputy manager at PNB, being named as one. The massive fraud was perpetrated for over seven years by Nirav Modi and his firms, by procuring LoUs from PNB.
What is it?
Technically, Letter of Undertaking is a bank guarantee under which a bank allows its customer to raise money from another Indian bank’s foreign branch in the form of short-term credit. The loan is used to make payment to the customer’s offshore suppliers in foreign currency. The overseas bank usually lends to the importer based on the LoU issued by the importer’s bank.
So, let’s say Nirav Modi, whose diamonds have sparkled on the necklines of Bollywood and Hollywood A-listers, wants to import diamonds for a new collection. He approaches PNB and asks it to arrange for a guarantee in the form of LoU for short-term loans from the foreign branches of Indian banks, to pay his diamond supplier. Bank officials promptly send instructions from PNB’s Mumbai branch to other overseas banks offering LoUs. The messages are sent through SWIFT — an inter-bank messaging network for securely transmitting instructions for financial transactions.
Theoretically, such SWIFT instructions need to be recorded in a bank’s core banking system. But thanks to the connivance of bank officials at PNB, the actual LoUs issued over the past seven years to Nirav Modi managed to escape scrutiny.
These guarantees never figured in the bank’s books. According to the CBI FIR filed by PNB, a total of 153 LOUs were issued in 2017, amounting to a little over ₹3,000 crore.
Why is it important?
LoUs are important instruments that allow those in the import trade to transact their business. As an importer in India cannot simply buy dollars and send it abroad to make payments to his supplier, various instruments such as LoUs and Letters of Credit are required to carry out the transaction. LoUs, which are essentially a form of guarantee, have come to be a far cheaper and convenient way for importer to raise credit. Nirav Modi, for instance, essentially had two options to make the payment to his supplier. One, he borrows money from PNB in rupees, converts it dollars, and pays his supplier, probably a diamond or pearl merchant. But here, the interest rate on such loans would be at the higher domestic rate, say 12-13 per cent.
The other way would be through a bank guarantee offered by PNB. The bank would simply instruct the overseas bank through SWIFT to remit funds into PNB’s overseas account, which is in turn used to pay Modi’s supplier. PNB earns a fee and the overseas bank offering the credit charges an interest at a spread over LIBOR. In effect, Nirav Modi gets a cheap line of credit.
So where does the fraud come in? In theory, having used the imported diamonds to fashion jewellery, Modi should have sold his wares and raised cash to settle the dues against LoUs. In this case though, the loan was not paid back by Nirav Modi at all. By repeatedly rolling over the loan, he ensured that new LoUs were used to repay earlier LoUs. So, there had been no default till now.
Why should I care?
If you’re a depositor or investor in bank stocks, these instances shake up your already shaky faith in the system. Banks, supposed custodians of public money, have been making headlines for all the wrong reasons. Time and again, the RBI, has been stepping in to flush out the NPA rot in banks’ books over the past two to three years. The Nirav-PNB scam has only brought to light another festering issue within PSU banks — absolute failure of control systems and governance structure. And this time, auditors and even the RBI, which scrutinises banks’ books regularly through various audits, are answerable.
The bottomline
At PNB, LoU’s labour’s lost!
A weekly column that puts the fun into learning
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