Author: R. Tejasree, Damodaram Sanjivayya National Law University
To the Point
The Punjab National Bank (PNB) scam centers on the fraudulent issuance of Letters of Undertaking (LoUs) amounting to ₹10,000 crore. Key figures involved include jeweller and designer Nirav Modi, his maternal uncle Mehul Choksi, other family members, and some PNB officials. In early 2018, Nirav Modi and his family members left the country shortly before the fraud was uncovered. This scam is regarded as the biggest banking fraud in Indian history.
At PNB’s Brady House branch in Fort, Mumbai, fake Letters of Undertaking (LoUs) were issued by bank officials. These LoUs were sent to overseas branches of Indian banks to support the import of pearls, usually for a duration of one year, even though Reserve Bank of India (RBI) guidelines allowed a maximum period of 90 days from the date of shipment for completing such transactions.
However, the overseas branches of Indian banks ignored these RBI regulations and did not share any documents or information with PNB, despite having received them from the firms at the time of granting credit. Nirav Modi received his first fake guarantee from PNB on March 10, 2011, and went on to obtain a total of 1,213 such fraudulent guarantees over the following 74 months. The Enforcement Directorate (ED) later seized bank token devices linked to shell companies abroad, which the absconding diamond merchant used to move the illicit funds.
In February 2018, Punjab National Bank (PNB), one of India’s largest public sector banks, became embroiled in a major financial scandal involving fraudulent transactions amounting to ₹11,400 crore. The bank informed the Bombay Stock Exchange that it had discovered a number of “unauthorised and fraudulent transactions” at one of its Mumbai branches, amounting to around $1,771.69 million. Following this, the Central Bureau of Investigation (CBI) received two separate complaints from PNB against billionaire jeweller Nirav Modi and a jewellery firm, accusing them of fraudulent dealings worth ₹11,400 crore. This was in addition to an earlier case involving a ₹280 crore fraud, which was already under investigation against Nirav Modi, also based on a complaint by PNB.
Abstract
A reliable and efficient banking system is essential for the smooth functioning of the economy. While the Indian banking sector has seen rapid growth, it has also encountered numerous challenges. Recent incidents of fraud have exposed its vulnerability to risks such as embezzlement, scams, and other financial misconduct. Research indicates that the increasing number of such frauds has compromised the trustworthiness of financial reporting. Banking scams often referred to as banking fraud pose a significant threat, especially at a time when the focus is on bank recapitalization.
One major instance is the ₹12,700 crore fraud uncovered at Punjab National Bank (PNB). Over the past five years, public sector banks have collectively lost around ₹22,700 crore due to such fraudulent activities. This has also brought into question the role and credibility of third parties, including auditing firms. Nirav Modi, an Indian diamond trader and founder of Gitanjali Gems and Firestar Diamond both established in 2010 was a key figure in the PNB scam, allegedly colluding with senior officials at PNB’s Mumbai branch.
The Reserve Bank of India (RBI), as the nation’s central banking authority, has faced widespread criticism for its failure to detect such large-scale frauds. There is now an urgent need for all public sector banks to critically review their internal systems and implement robust measures to prevent such occurrences. This article aims to investigate issues related to bank fraud, with a specific focus on identifying the root causes of major scams. It also analyses weaknesses in the auditing process and points out the gaps that allowed the fraud to occur. Finally, the study offers recommendations to help prevent future banking frauds in India. The PNB scam, involving multiple individuals and entities, stands as a major example of systemic failure in the sector.
Use of legal jargon
While the government is concentrating on recapitalizing banks, the PNB scam has severely undermined the credibility of the entire banking sector. The ₹12,700 crore fraud, which involves at least six banks, has raised serious concerns about the internal security and operational integrity of financial institutions. Public Sector Banks (PSBs) have collectively suffered losses of approximately ₹22,700 crore due to frauds over the past five years. The sheer scale and duration of the PNB scam which went undetected for over five years highlight major flaws in internal controls and auditing mechanisms. The Reserve Bank of India (RBI), as the country’s apex bank, has come under intense public criticism for failing to identify such a massive fraud. There is now an urgent need for all PSBs to reassess their internal systems and implement corrective measures. This case falls under the offence of cheating as defined under Section 420 of the Indian Penal Code (IPC). As per Section 420, the accused can be punished with imprisonment of either kind for a period that may extend up to seven years, along with a monetary fine. Moreover, the case is also classified as a criminal conspiracy under Section 120B of the Indian Penal Code (IPC).
Case law
Punjab National Bank (PNB), one of India’s major public sector banks, was incorporated in 1895 in Lahore, then part of undivided India. It holds the distinction of being the first Indian bank to be established solely with Indian capital by 1940. PNB absorbed Bhagwan Das Bank, a scheduled bank in the Delhi circle, and was nationalized in July 1969 along with thirteen other major banks. The bank later acquired Hindustan Commercial Bank, adding 142 of its branches to PNB’s network. Headquartered in New Delhi, PNB is a state-owned multinational banking and financial services company. As of March 31, 2017, the bank served more than 80 million customers, operated 6,937 branches, and had 10,681 ATMs in 764 cities. It was officially incorporated on May 19, 1894, under the Indian Companies Act, and was established by Dyal Singh Majithia.
Its first office was in Anarkali Bazaar, Lahore, now in Pakistan. Following the partition, PNB relocated to India and shut down its Pakistani branches.
In February 2018, PNB found itself at the canter of one of the largest frauds in Indian banking history, involving a ₹11,400 crore scam. The bank initially discovered and reported to the Bombay Stock Exchange about “fraudulent and unauthorized transactions” at its Brady House branch in Mumbai, amounting to approximately $1.77 billion. PNB then filed two complaints with the Central Bureau of Investigation (CBI) against billionaire diamond merchant Nirav Modi and a jewellery firm, alleging fraud. This was apart from a previous ₹280 crore fraud case already being investigated, which also involved Nirav Modi. On January 29, 2018, PNB lodged a criminal complaint with India’s federal investigative agency against three companies and four individuals, including Nirav Modi and Mehul Choksi, the Managing Director of Gitanjali Gems. The complaint claimed they defrauded the bank, causing an initial loss of ₹2.8 billion ($43 million), which was later revised to ₹11,394 crore ($1.77 billion) after further internal investigation.
Nirav Modi, who imports diamonds, benefited from lower foreign currency interest rates and took loans from overseas banks guaranteed by PNB through Letters of Undertaking (LOUs). Beginning in 2011, he fraudulently raised ₹12,636 crore from various public and private sector banks using LOUs issued by PNB. Staff at the Brady House branch issued these LoUs for a period of 365 days without obtaining any collateral and without recording them in the Core Banking System (CBS). Modi’s companies used these guarantees to secure buyer’s credit from overseas branches of Indian banks to pay their suppliers. When the firm requested another LOU in January 2018, a bank official demanded collateral, as there was no pre-approved credit limit. Upon reviewing records, the official found no prior transactions, leading to the complaint filed with the CBI.
According to the complaint dated January 28, the fraudulent issuance of LOUs was identified at PNB’s mid-corporate Brady House branch. On January 16, three partnership firms Diamond R US, Solar Exports, and Stellar Diamonds submitted import documents and requested buyer’s credit to pay overseas suppliers. Without an existing credit limit, bank officials asked for full collateral. The refusal to provide new LOUs led to the exposure of the fraud.
CBI registered a case against Nirav Modi on January 29 and against Nirav Modi, Neeshal Modi, and Mehul Choksi on February 13. The initial ₹280 crore fraud estimate was later found to be ₹11,400 crore. Nirav Modi and Mehul Choksi fled the country before the fraud became public. CBI arrested 13 individuals seven from the bank and six from companies linked to Modi and Choksi. Investigators seized various properties, including jewellery and luxury vehicles. The bank’s auditors were criticized for negligence. Foreign banks such as Allahabad Bank, Union Bank of India, and Axis Bank were held responsible for not properly monitoring the NOSTRO accounts. The Reserve Bank of India faced public criticism for lack of oversight, and the Finance Ministry was scrutinized as the government holds a significant share in public sector banks.
Out of the ₹11,400 crore loss, PNB will attempt to recover part of the amount by seizing Nirav Modi’s assets, while the remainder will be covered by the bank itself. The government may provide financial assistance to support the bank.
Conclusion
Frauds can significantly affect institutions like banks, leading to substantial economic costs by potentially disrupting market operations, financial institutions, and the payment infrastructure. Moreover, such scams can erode trust in the banking system, compromising both the integrity and stability of the overall economy. They have the potential to cause bank failures, weaken the central bank’s regulatory authority, and even incite social unrest, dissatisfaction, and political instability. The growing reliance on technology has further intensified banks’ vulnerability to fraudulent activities.
The Punjab National Bank (PNB) fraud revealed major credit risk exposure and operational failures across banks, particularly in verifying transactions before issuing non-funded loans. The 5W2H analysis emphasized the need for strict adherence to standard procedures and effective control mechanisms to prevent such risks. A key compliance lapse involved the unchecked use of the SWIFT messaging system, which enabled collateral-free transactions with Nirav Modi’s firms, undetected for seven years. This highlights weaknesses in internal risk management and the lack of oversight from both internal and external audits. The incident also raises concerns about the effectiveness of regulatory supervision by the Reserve Bank of India (RBI), despite existing risk mitigation guidelines. There is a need to empower banks to respond swiftly to fraud without bureaucratic delays. In addition to financial losses, the scam has tarnished the reputation of the banking sector, especially at a time of global banking reforms. The recapitalization of public sector banks burdened by NPAs may require re-evaluation in light of such recurring frauds.
FAQS
1. Who is Nirav Modi and what was his role in the scam ?
Nirav Modi is a luxury diamond jeweller and founder of the Nirav Modi jewellery chain. He was one of the main accused in the PNB scam and allegedly used fraudulent LoUs to secure funds through foreign dummy companies. He fled India in early 2018 and is currently in the UK seeking political asylum.
2. How did the scam remain undetected by PNB management?
PNB employees misused the SWIFT network to send messages to other banks without recording these transactions in the bank’s core system. This prevented the PNB management from detecting the scam for years.
3. What was the core issue in the Punjab National Bank (PNB) scam involving Nirav Modi?
The core issue was the fraudulent issuance of Letters of Undertaking (LoUs) by two PNB employees without securing collateral, enabling Nirav Modi and his associates to obtain loans from foreign banks through PNB’s SWIFT network, which was not integrated with the Core Banking System.
4. What legal actions were taken following the detection of the PNB scam?
Legal proceedings included FIRs by PNB, CBI investigations, arrests of Nirav Modi and others, asset seizures under the PMLA, freezing of foreign bank accounts, and extradition efforts, with the ED and CBI filing charge sheets and pursuing the attachment of properties and declaration of key accused as proclaimed offenders.
5. How did the PNB fraud affect other banks and the financial market?
The fraud impacted several banks, with Union Bank of India losing Rs 633 crores in market capitalization, Allahabad Bank Rs 484 crores, Axis Bank over Rs 4,800 crores, and SBI Rs 8,329 crores between February 12th and 15th, 2018, reflecting shaken investor confidence and significant value erosion.
