Author: Harshitha R, a student at Dayanand Sagar University,Bengaluru.
The Nirav Modi financial scam is among the biggest in Indian banking history—not only because of the whopping figure of over ₹13,500 crore but also since it exposed egregious structural weaknesses within the public sector banking system. This was not a matter of individual fraud alone; it exposed systemic weaknesses, internal complicity, and legacy infrastructure within the financial institutions.
How the Scam Unfolded
In February 2018, Punjab National Bank (PNB), one of the largest government-owned banks, reported fraudulent transactions from its Brady House branch in Mumbai. The unauthorized transactions were traced to famous diamond traders Nirav Modi and Mehul Choksi. The two used several fake Letters of Undertaking (LoUs) to raise credit from overseas banks—without offering any collateral or activating the bank’s internal systems.
Understanding LoUs and Their Abuse
A Letter of Undertaking is a bank’s official guarantee to another bank to pay back on the customer’s behalf. These normally need multiple stages of approval, exhaustive documentation, and registration on the bank’s Core Banking System (CBS). But in this fraud, LoUs were raised without following any of these steps, making them undetectable to bank audits.
Mechanics of the Fraud
The fraud was facilitated by PNB employees who misused SWIFT—the global financial messaging platform—to send unauthorized LoUs. The absence of integration between SWIFT and CBS was a critical weakness. Employees, particularly Deputy Manager Gokulnath Shetty, exploited this loophole by using unauthorized credentials, avoiding audits, and repeatedly issuing fake guarantees to Nirav Modi’s firms such as Stellar Diamonds and Diamond R US. This malpractice continued unchecked for several years.
Investigations and Findings
When the scam broke, Indian enforcement authorities, such as the Central Bureau of Investigation (CBI) and the Enforcement Directorate (ED), initiated large-scale investigations. They uncovered fictitious bills, shell firms, and an elaborate money laundering network. More than 25 persons have so far been arrested and ₹2,000 crore assets have been confiscated. The scandal brought to the fore a generic breakdown in financial regulation, raising hard questions about regulatory alertness and internal responsibility.
Legal and Institutional Response
To bring the perpetrators to justice, several laws were invoked:
- Section 120B of the IPC: Criminal conspiracy
- Sections 420, 467, 468 of the IPC: Fraud and document forgery
- Section 3 of the PMLA: Dealing with laundering of illicit funds
- Fugitive Economic Offenders Act (2018): Designed to confiscate assets of fleeing economic offenders
- Extradition Act (1962): Used to push for Modi’s return from the United Kingdom
Afterwards, Reserve Bank of India (RBI) prohibited issuing LoUs for international trade credit and ordered all banks to implement SWIFT with CBS to prevent such blind spots.
Key Legal Precedents
There have been some significant legal judgments that have guided the direction in this case:
- CBI v. Nirav Modi (UK, 2021): The UK court confirmed that Modi had a case to answer in India and ordered extradition in favor of it, dismissing Indian prison conditions concerns.
- PNB v. Nirav Modi Group (DRT, 2020): Modi was formally declared a “wilful defaulter,” and his assets were sanctioned for seizure.
- SBI v. Vijay Mallya (2017): Though a separate case, it underscored the need to enforce accountability for company promoters in loan defaults.
- Union of India v. Rathi Steel (2020): The court emphasized the duty of banks to perform proper due diligence before issuing credit.
- Nirav Modi v. ED (Bombay High Court, 2019): Modi’s objection to property seizures was dismissed, validating ED’s enforcement powers under anti-money laundering laws.
Extradition Struggles and Global Implications
Although a UK court has approved Nirav Modi’s extradition, he continues to appeal the decision. The lengthy legal process highlights the challenges India faces in bringing back economic fugitives. Legal complexities in foreign jurisdictions, slow procedures, and diplomatic hurdles often lead to delayed justice.
Why the Scam Still Matters
This scam is not merely about a single businessman—it is an indicator of systemic failure. The unregulated application of financial instruments such as LoUs, without regulatory protection, demonstrated how institutions in India and overseas did not check high-risk transactions. It initiated worldwide debates on increasing financial transparency and enhancing internal controls within banking systems.
Post-Scam Reforms
The case led to a spate of reforms to fill the loopholes revealed:
- Abolition of LoUs for import credit
- Forced integration of SWIFT and CBS systems in all banks
- Enhanced internal audits and compliance checks
- Enforcement of the Fugitive Economic Offenders Act to speed up seizure of assets
- Focus on strengthening corporate governance and utilizing technology in public sector banks
Challenges That Endure
- Even after numerous corrective steps, some obstacles continue to persist:
- Delays in extradition: Proceedings abroad are time-consuming, slowing down swift action.
- Complexity in recovery of assets: International laws make it difficult to recover assets
- Slow prosecution of white-collar crimes: India does not have an effective mechanism to expedite the processing of white-collar crime cases
- Reactive, not preventive: Systems tend to act only after frauds are detected, and not to prevent them
Looking Ahead
To avoid similar future occurrences such as the Nirav Modi scam, India needs to:
- Use real-time monitoring systems for compliance
- Strengthen whistleblower mechanisms to promote early reporting
- Use artificial intelligence to identify suspicious activity early
- Provide regular rotation of personnel to prevent internal collusion
- Enforce strict access controls on financial systems
Most importantly, accountability is not to be confined to the lower rungs of the corporate ladder. Senior management and directors also need to take responsibility for failures of oversight in massive financial scandals.
FAQs
Q1: What is a Letter of Undertaking (LoU), and how was it exploited in the scam?
A Letter of Undertaking is a formal commitment by one bank assuring another bank that it will repay a loan taken by its client. In this case, Nirav Modi managed to get such LoUs issued without providing any collateral or going through the necessary approvals. This allowed him to secure enormous foreign credit without triggering any alarms.
Q2: How did Nirav Modi manage to escape India?
Modi left the country in January 2018, just days before Punjab National Bank publicly revealed the fraudulent transactions. His exit was smooth due to weak monitoring systems and the absence of preemptive legal action.
Q3: What role did the bank officials play in facilitating the fraud?
Certain employees at PNB conspired to generate unauthorized LoUs through the SWIFT system while deliberately omitting any record in the Core Banking System. This manipulation helped bypass standard verification protocols and enabled repeated misconduct.
Q4: What legal provisions were invoked against Nirav Modi?
Authorities pursued action under several legal frameworks, including sections of the Indian Penal Code for conspiracy and fraud, the Prevention of Money Laundering Act (PMLA), the Companies Act, the Fugitive Economic Offenders Act, and the Extradition Act for securing his return from abroad.
Q5: Has any of the misappropriated money been recovered?
The Enforcement Directorate has seized assets worth over ₹2,000 crore. However, most of these are still tied up in international legal proceedings, delaying their actual recovery.
Q6: What lessons should banks take away from this case?
Financial institutions must integrate all their systems for transparency, adopt AI-enabled fraud detection tools, carry out regular internal audits, ensure periodic staff rotation, and implement a strong whistleblower framework to detect and prevent such frauds in the future.
