Author: Rupashree Meher, a student of Amity University Chhattisgarh, Raipur
Introduction
In February 2018, India’s biggest-ever banking fraud rattled the very core of the country’s financial industry. This Case is often known as Nirav Modi Scam that involves, a sum of Rs.11,400 crores (about 1.8 billion dollars) which was fraudulently obtained from several public and private sector banks by presenting a Letter of Undertaking (LoU) that was issued by Punjab National Bank. The fraud was allegedly organized by billionaire Nirav Modi , his maternal uncle Mehul Choksi, the owner of Gitanjali Group, a retail jewellery firm in India along with PNB officials and employees. It mainly took place at Brady House Branch in Fort, Mumbai of Punjab National Bank (PNB) the nation’s second-largest lender to the public sector. This article examines the various facets of this billion-dollar fraud, focusing on its analysis and legal implications.
NIRAV MODI: Who is India’s scandal-tied millionaire?
Nirav Modi is a luxurious diamond jewellery designer, who was born on February 27, 1971, into a family of diamond traders in Palanpur, Gujarat. He grew up in Antwerp, Belgium, where his family had been involved in the diamond trade for many generations. He attended the Wharton School at the University of Pennsylvania but dropped out before completing his studies. Later at the age of 19, Modi and his father Deepak Modi returned back to India and shifted to Mumbai to join his uncle Mehul Choksi and his Gitanjali Group, which was a retail jewellery enterprise with approximately 4000 stores in India.
Though Nirav Modi will be remembered as a scammer, he was an undeniably successful and visionary businessman. The following achievements and distinctions demonstrate his great business skills:
- In 1999, Nirav Modi launched the Firestar Diamond International Company, specializing primarily in fine jewellery. The company swiftly rose to become one of India’s largest diamond companies, and Modi was named one of the country’s most successful young entrepreneurs.
- In 2010, Modi made history as the first Indian jeweller to appear on the covers of Christie’s and Sotheby’s catalogues. He was listed among the Indian billionaires by Forbes in 2013.
- In addition, the brand “NIRAV MODI” was established in 2014 when its first store opened in New Delhi, India; in 2015, Nirav Modi opened stores in Mumbai; in 2016 he opened stores on Madison Avenue in New York; and in Hong Kong; his company is said to have generated over $2 billion in sales.
- Also, he owns other businesses under the names Diamond R US, Solar Exports, and Stellar Diamonds.
- Luxury diamond jewellery designer Nirav Modi came in at number 57 on Forbes’ 2017 list of billionaires. He was referred to as one of the Indian diamond kings during the height of his prosperous business career, and Kate Winslet wore his jewelry to the Oscars.
Before the PNB Scam hit the headlines in 2018, Nirav Modi was reported to have a net worth of $1.7 billion. His net worth plummeted like an avalanche as the scandal became viral, and Forbes also took his name off their list of billionaires.
How the PNB Scam Was Executed: A Deep Dive into the Nirav Modi and Mehul Choksi Case
The intricate scheme was masterminded by Nirav Modi and his uncle Mehul Choksi, working together with a few Punjab National Bank bank personnel, while investigations into the matter are still underway. To understand the mechanism of this grand greedy plan to defraud a leading public sector bank, it is necessary to first define the term Letter of Undertaking (LoU), as it was the unauthorised LoUs granted to Nirav Modi and Company by corrupted PNB officials that enabled Modi to flee with thousands of crores of taxpayers’ hard-earned money.
So, LoU stands for Letter of Undertaking, a type of bank guarantee. This bank guarantee in the form of a LoU permits the LoU receiver to collect funds overseas by displaying the LoU. Foreign banks (overseas branches of Indian banks) see the LoU and extend credit/loans to the debtor, with the bank issuing the LoU serving as a guarantee that if the debtor fails to repay the debt, the bank will repay it. When a person walks into a bank to obtain a letter of credit, the bank normally requests collateral in the form of a Fixed Deposit (FD) or property held in his name. The bank that issues the letter of authorization also approves a credit limit. In summary, LoUs provided inexpensive buyer credit for temporary needs.
In this scam, Nirav Modi and his company received unauthorized Letters of Undertakings (LoUs) from dishonest PNB employees. These LoUs were granted in the absence of any approved credit limit or collateral. To make matters worse, none of these transactions were added to the PNB’s Core Banking System (CBS), which is utilized for record-keeping. All of these illegal LoU transactions were carried out by corrupt officials utilizing the SWIFT system, which is an extensive messaging network utilized by banks and financial organizations around the world to send and receive financial information precisely, rapidly, and securely. The SWIFT system was not linked to the bank’s record keeping core system, CBS, allowing Nirav Modi and his cronies to operate in the shadows using illegal LoUs. In other words, SWIFT bypassed the bank’s CBS. Since the foreign Indian bank branches trust their Indian counterparts, they extended loans (buyer’s credit) to Nirav Modi and his enterprises without first assessing credit quality. Furthermore, while these LoUs were granted for import-related payments, Nirav Modi and his associates utilized them to repay previous loans and for other purposes. Nirav Modi, Mehul Choksi, and their colleagues, in cooperation with corrupt PNB officials, allowed this to continue unabated in the shadows for approximately seven years.
Exposing the PNB Scam: How and When it Came to Light
As previously mentioned, this scam was carried out at a Mumbai branch of PNB in coordination with dishonest employees. A new official replaced the dishonest official who had retired. However, when this officer requested collateral from Nirav Modi and his companies in order to give LoUs in accordance with the rules, he was informed that these parties have been receiving LoUs without collateral for a number of years. Additionally, PNB received a hammering from the international banks that had lent money to Nirav Modi and his companies on the basis of PNB’s LoUs. Internal investigations had begun at this point, but no records of the unauthorized transactions had been located since the corrupt officials had not kept the necessary records of unauthorised LoUs in the bank’s CBS (Core Banking System).
As a result, on February 14, 2018, the Nirav Modi scam made headlines when Punjab National Bank, the second-largest public sector bank, helplessly reported fraudulent transactions totaling an astounding 1.8 billion dollars (approximately) to stock exchanges, the Reserve Bank of India (RBI), and the public.
The Scam’s Shadow: A Look at the Aftermath
Following the scam’s discovery, there was never before seen consequences. The reason behind this is that the general public found it intolerable that billions might be squandered by businessmen. However, Nirav Modi, his younger brother, Mehul Chowksi, and his wife had already left the nation when the news first surfaced. Even though the loans were obtained from Indian banks, they were taken out of other countries, therefore the Indian banking industry suffered the brunt of the scam. In the end, the banking industry needed to be saved by the government once more. Several PNB officials were arrested. Top PNB officials said that the scheme occurred because few PNB workers were engaged. They further claimed that the scam was possible due of flaws in the banks’ SWIFT systems. However, these charades were impossible to buy because billions of dollars could not just disappear from the bank without the involvement of top bank executives.
On March 13, 2018, nearly a month after the fraud made news, the RBI issued a notice prohibiting banks from issuing guarantees in the form of Letters of Undertaking (LOU) to avoid further exploitation of this tool with immediate effect. As a result of the RBI’s directive, commercial banks in India have ceased the procedure of issuing LoUs for trade-related credits for imports with immediate effect.
The RBI also ordered that the SWIFT system be linked to the banks’ record-keeping system, known as the Core Banking System (CBS), by the specified deadline. Nirav Modi was accused with criminal conspiracy, cheating, dishonesty, fraud, violation of trust, and breach of contract. The banking, jewellery, and insurance sectors all saw significant negative consequences. PNB was scheduled to repay around Rs. 11,400 crores (about 1.8 billion dollars) owed in the form of bank guarantees to overseas branches of Indian banks such as UCO Bank, Allahabad Bank, Axis Bank, Union Bank of India and SBI.
Strengthening India’s Banking System: Reforms Post Nirav Modi Scam
The following reforms were implemented following India’s largest banking fraud:
- On March 13, 2018, around a month after the scam made headlines, the Reserve Bank of India (RBI) issued a notice prohibiting banks from issuing guarantees in the form of Letters of Undertaking (LoU) to avoid any further exploitation of this provision with immediate effect. As a result of the RBI’s directive, commercial banks in India have ceased the procedure of issuing LoUs for trade-related credits for imports with immediate effect. Experts later criticized the RBI’s full prohibition on LoUs as a panic-driven move.
- The RBI also ordered that the SWIFT system be Integrated with the banks’ record-keeping system, known as the Core Banking System (CBS), within the dates specified. SWIFT’s integration with CBS will help to prevent similar scams in the future. A better Risk Management Framework was implemented, together with an efficient system of checks and balances, to optimize the risk management system.
- The RBI had also formed an expert committee, led by YH Malegam, a former member of the RBI’s Central Board of Directors, to investigate the reasons for the high divergence in asset classification, various incidents of fraud, breach of trust, and necessary interventions (including IT intervention) to prevent such frauds in the future.
- The RBI also Issued a Prompt Corrective Action (PCA) framework to banks such as UCO Bank, Dena Bank, IDBI Bank, Oriental Bank of Commerce, Indian Overseas Bank, Central Bank of India, Corporation Bank, Bank of India, Bank of Maharashtra, Allahabad Bank, and United Bank of India to encourage them to avoid riskier banking practices and focus on capital conservation.
- The RBI also directed banks to tighten their usage of the SWIFT framework, to limit foreign currency payment instructions to people, and to implement an additional layer of protection on transactions over a specific level.
- To address the issue of offenders fleeing to foreign countries and avoiding punishment, the Indian government established the Fugitive Economic Offenders Act (2018). Any person who has committed offences under this Act, such as counterfeiting government stamps or currency, cheque dishonour, money laundering, transactions defrauding creditors, and other offences totaling Rs. 100 crores or more, has fled India to avoid prosecution, and refuses to return, can be declared a fugitive economic offender.
- Furthermore, the federal government has the authority to confiscate all of his holdings (including benami properties), and all rights and titles to the properties will vest in the Indian government without encumbrance.
Conclusion
The average man’s suffering was evident when the Nirav Modi scam made news in the spring of 2018, as evidenced by the lengthy lineups and dejected crowds that gathered in front of their bank branches. The Nirav Modi scandal caused the largest banking earthquake in Indian history, and its aftershock caused investors’ money to be lost by thousands of crores of rupees as the stock market plummeted and sank. While many reforms, such as the Fugitive Economic Offenders Act (2018), the integration of SWIFT with the Core Banking System, stricter regulations, etc., were implemented following this scam, there is still no concrete evidence of an effective deterrent that would prevent future Nirav Modis from meddling with India’s economy. Until more stricter laws and regulations are enacted, as well as procedures to assure full compliance with such security regulations, the threat of greedy fraudsters in the banking sector will remain far from eradicated.
