After Nirav Modi scam at PNB, fear of sweetheart deals at other banks too

The case surfaced as a rule change by RBI in early January forced PNB to tap Nirav Modi and other importers for more margin money, and a query from the central bank about two 'tainted' PNB officials

These are early days in the Nirav Modi saga, but top financial sector officials are not ruling out more such sweetheart deals at other banks, given that the overseas bill discounting business that traders deal in is highly porous. 

The present case has surfaced because an innocuous rule change by the Reserve Bank of India (RBI) in early January forced Punjab National Bank (PNB) to tap Nirav Modi and other importers for more margin money. Another trigger, it would seem, was an alleged query from RBI seeking the bank’s response over one of its officials allegedly demanding favours from Modi’s company in return for issuing the next Letter of Undertaking, or buyer’s credit. 

The recent developments have also effectively nixed the bank’s plans to merge any other state-owned bank with itself until the scam fire is doused – and that will take quite some time. 

Another associated issue is how two of the bank’s employees continued undisturbed in their perch for so many years.

Change of rules

Having started the process to tighten the recognition of bad loans at banks, RBI has sought to harmonise the definitions of business terms used by banks. The exercise, going on since 2014, has made more transparent the meaning of each term in balance sheets, in profit-and-loss statements, and, more critically, what make off-balance sheet items. 

On January 4, it sent across another list of those terms, including among them the category of “non-fund-based advances”. These include buyer’s credit or letters of undertaking — simply put, a guarantee from an Indian bank on behalf of enterprises like Nirav Modi’s to a foreign bank for financing their import. PNB and officials of other banks read it to interpret that RBI would soon start examining this line of business as well, minutely. 

Since Indian banks do not need to offer capital but receive collateral or margins from customers, instead for offering letters of credit, such buyer’s credits were issued with abandon, especially if the parties involved had close relations with the banks concerned. Across the world, banks offer their customers stand-by letters of credit, making trade across countries safer to negotiate. Normally, there are four parties to any deal – two banks, the buyer, and the seller. At times, there also are one or more banks to offer additional comfort to the transaction. The entire mechanism assures sellers of goods that they would get their payment irrespective of the buyer’s fate. The term stand-by came into existence in early last century – when American banks were precluded from offering guarantees for overseas trade, they used the word stand-by as a substitute. 

The RBI, wary of the continuously rising bad loans of Indian banks, wanted to know the full extent of their non-capital exposure as well. Or, that was what some of the bank officials felt. 

Additional margin money

There are reports that PNB officials, faced with these constraints, demanded higher margin money – and then some more – from Diamonds R US, Solar Exports and Stellar Diamonds, which approached the bank for ‘buyer’s credit’ to make payments to overseas suppliers. Neither PNB nor RBI responded to these allegations. 

A former chairman of one of the state-owned banks said he was surprised that the relations came unstuck over the demands for a higher margin money. “Higher margins are supposed to be sought routinely, whenever the size of buyer’s credit rises,” he said. 

In its complaint to CBI, PNB noted that the demand for a 100 per cent cash margin was made, as there was no pre-sanctioned limit for these firms. The Nirav Modi enterprises refused, as they read the demand for higher margins as a signal for favours, given that they had not paid any margins earlier. 

What they had not factored in was that PNB officials would use their declarations to fish out previous files as well. As the details of buyer’s credit tumbled out, the officers were left aghast. 

More rot at other banks?

On Thursday, the entire officer strength of the department of financial services, in the finance ministry, was roped in for fire-fighting. Beyond PNB, their immediate job was to figure out how many more state-owned banks had issued such dubious LCs. They are worried that the arrangement tapped into by the Modi companies could have been used at other banks as well. 

Finding rogues, though, would be a tedious task, as that essentially means matching each LC with the collateral or margin money demanded. While the officers said such a possibility was remote, they also conceded that no checks or balances had worked at PNB to prevent the largest banking sector fraud in India. 

Undisturbed ‘tainted’ officials

Another issue that will need to be sorted out is how PNB’s human resources department allowed two offenders to continue in their seats for rather long. The bank has a transfer policy, under which each executive has to be transferred after every three years. If the officer has been promoted, he has to be transferred automatically even before the three-year term. One of the two said officials had been promoted to the rank of deputy general manager during the time he serviced the Modi accounts. There was no effort to remove him or his assistant from their posts for years. An HR department source said it was difficult to draft in officers willing to work in specialised departments like forex or large credit appraisals. They claim there was no malafide in the said official’s long run in the chair, until he retired in November 2017. 

The PNB top brass, as of now, is too shell-shocked to answer the query, but these questions are expected to surface soon.