PNB FRUAD –
an eye opener
What is
banking?
Banking is dealing with public money by
accepting deposits from the public and lending to them to earn profit out of
the transactions. Till 1985, Indian
banking had a strong system and procedure and whatever work you do there is
clear systems and procedures which includes the accounting procedure and
reporting also. When the banking system
starts computerizing their operations starting from 1985, it is presumed that
the computers will not do any mistakes and whatever reports generated by the
computers were accepted as it is, without any verification process. We used say
in a lighter vain that if you generate a resignation letter through the
computer, it will be signed by the manager without any hesitation.
The department of technology in the banking
sector does not coordinate with the operation department and User Acceptance
Test is also done by a group based on the operating instruction but they do not
have much exposure to the operation.
Now the bank in order to increase the
profitability by selling insurance, credit cards etc under the name cross
selling and to increase the cross selling activity, incentives are given to all
the people starting from the marketing team at the branch to the top Management
of the bank. Therefore, the top Management
is only interested in the incentives instead of their core banking activity.
The core banking activity has been pushed to back seat at the bank as the top Management
drive the entire unit towards the cross
selling activity.
Till 1990, the banking is traditional but thanks
to globalization, the banking has transformed into global business with many
complicated products and cross border transactions. The products “buyers
credit”, “Suppliers Credit”, options, swaps etc., are predominant and availed
by the borrowers in order to reduce the cost of borrowings. Due to
globalization process, Indian customer has access to the international Market
for their borrowing to reduce the cost of borrowings. But the bank has not
implemented the risk management and compliance process as per international
standard although they have some position as Risk manager and banking operation
department to take of compliance. These people will be working directly under
the operation department hence their
reports are not effective.
The top Management also of the opinion that the department
compiling the returns, system and procedures, control frauds, risk management
departments etc are useless and the people working therein are also will not
receive any recognition for their good work. Therefore, people who wants go up
in the cadre will not incline to work in these departments.
Now come to
the fraud of PNB:
Mr. Nirav Modi wanted to import pearls and diamonds, design
exquisite world-class jewellery and sell them. He needed money to buy the
pearls and diamonds. He did not want to opt for a rupee loan, and rightly so as
it is expensive and there is foreign currency risk. He wanted foreign currency
loan. That’s cheap and he had a natural hedge against currency fluctuations as
he was earning in foreign currency by exporting jewellery.
As the loans is foreign currency loan arranged through the bank
abroad, and there will not be any entry in their accounting system except the
contingent liability by way of guarantee/ comfort letter. But in the PNB case
there is no loan account created in the books of the bank including contingent
liability and letter of comforts were issued through MT799 through swift to the
foreign bank for release of loan. RBI instruction in this regard is clear that buyers’
credit can be arranged through a bank abroad by issuing letter of comfort for
the import of goods (raw materials) or capital goods. The Buyers credit period
should not exceed the working capital cycle.
For any guarantee without any collateral, it is normal on the part
of the bank to ask for 100/110 % margins (to cover foreign exchange fluctuation
but PNB is liberal enough to do letter of comfort (LOC) without any margin.
When the devolvement of the LOCs takes placed the bank wake up to a USD 1.77
billion fraud that shook the Indian banking system. They had continued the
entire operations by opening one LOC to meet the liability on account of
previous LOC which is nothing but kite flying.
The
violations done by PNB
No loan appraisal has taken place and limit of letter of credit or
letter of comfort has been sanctioned. The MT799 has been issued without any
back up collateral as paper without understanding the implication or otherwise.
There is huge money flowing through the bank both inward and
outward and as normal practice it should be reported to the controllers at
least as forex sales and purchase figures.
The controller might not
have time to check these reports and arrive at a logical conclusion of the
business. On the other hand there is no risk management system prevailing at
the Apex office / forex managing branch to check the matching transaction of
inflow and outflow on regular basis.
The audit conducted by the Head office fails to track these
transactions as normally the person who does audit normally do not have an idea
about foreign exchange / trade related transactions.
Buyers
credit operations:
Most of the bank resort to the buyers’ credit through a bank
abroad to meet the import payments. The normal practice is to open a letter of
credit on usance term for import of Raw materials and on receipt of the goods
under the LC, the value of bill is paid by arranging through buyers
credit. It is nothing but converting a
non fund based facility into a fund based facility although it is contingent
liability to the bank by way LOU. But this may leads to double finance as the imported
materials might have been added to the stock pledged to the bank and availed
cash credit against the same. The banks do not have a proper SOP (standard Operating
Procedure) for the buyers’ credit as it will not reflect into their Books/CBS.
Although most of the bank claims that there is integration of CBS
and swift and the swift message is generated from the system automatically from
CBS, it is not fool proof as the verification/ authorization should be done in
Swift. There is a possibility of generating swift directly also without any
involvement of CBS.
What are the
learning points?
- Normally, the top management escapes out of such large frauds blaming of the people at the bottom which is not true. The fraud to the tune of Rs.11000 crores cannot be committed without the knowledge of the top management. Their failure for not managing the bank in a proper way by creating proper SOPs and strengthening the report system, audit system, risk management system etc, if at all they are really unaware of it which is a very remote possibility.
- The Technology is incomplete and do not have checks and balances required to be there because it is being rolled out at the urgency of the top management without giving adequate time for testing the roll outs. The Computerization is not done 100 % due to lack of coordination between IT and Operation department of the bank. Working knowledge is required for computerizing the operations which will not be available. The management / technology department do not take any feedback from the operations on the technology introduced in operation.
- Most of the time as the management never invests in developing the work force as they themselves do not have faith in the training system. Specialization of work is not supported by the Management.
- The due importance is not given by the management for support departments such as Risk Management, Audit, Vigilance, Training etc. and it is normal the management see them as not contributing to the bank as their contribution is invisible. I have personally come across top management blaming opening these departments that they have wasting their time and do not contribute to the bank’s growth.
- Top management is selected based on the political influence not based on their ability leads, deteriorate the management function of the of the Banks.
- Importance to cross selling at the cost of the core business by the management for personal interest of earning incentive.
- RBI also failed in their role as supervisor of the banking system, has never evaluated the technology upgrade and new product Standard Operating Procedures, and also audit of the Banks. Further, till now RBI has not insisted that Risk Management and compliance function should be reported to a different vertical and to RBI directly not to the Chairman of the bank.
- The management has withdrawn the concurrent auditor position at a medium and a large branch is a unwise action and shows their ignorant to the internal Audit function.
- Last but not the least, in the previous generation, the employees are wedded to the bank and work for the bank till they retire from service. The will be more committed to work because their stake of PF, pension is in the bank. Now, the generation switch between banks at least once in 3 to 5 years and hence it will difficult for the bank to understand the attitude and values of their employees.
Conclusion:
It is high time the bank should centralize the process of loans,
international Banking, liability products and marketing activities from the
branch and treat the branches as only a delivery points. Two / three stages of
verification of important process such as loan sourcing, appraisal , sanction,
administration, processing international banking activities, KYC process etc to
protect the interest of the bank. More training to be organized to enrich the
knowledge of the work force and also to inculcate the Risk management at each
stage of transaction. Enhance the supervision of Reserve Bank of India to
protect the public money and also financial sector stability of the country
