Author: Himani Jethwani

College: Jai Narain Vyas University, Jodhpur, Rajasthan

Abstract

The Punjab National Bank (PNB) fraud of 2018, involving fraudulent Letters of Undertaking (LoUs) worth approximately ₹13,578 crore orchestrated by diamond merchant Nirav Modi and his associates, exposed systemic failures across India’s public sector banking architecture, regulatory oversight framework, and internal audit mechanisms. This article examines the mechanics of the fraud, analyses the institutional and regulatory deficiencies it revealed, surveys the legislative and administrative responses that followed, and draws broader lessons for India’s banking and financial regulatory architecture. The PNB scandal was not merely a criminal episode; it was a diagnostic event that illuminated structural vulnerabilities in the functioning of Swift messaging systems, the role of correspondent banking, the adequacy of supervision by the Reserve Bank of India, and the governance culture of public sector banks. This article argues that meaningful reform requires not only stronger compliance mechanisms and penal frameworks but a fundamental restructuring of the supervisory relationship between the central bank and commercial banks, and a transformation of the internal governance culture within public sector institutions.

To the Point

In February 2018, Punjab National Bank, one of India’s largest public sector banks, disclosed to the Bombay Stock Exchange and subsequently to law enforcement authorities that it had discovered fraudulent transactions amounting to approximately ₹11,400 crore at the time of initial disclosure a figure that was subsequently revised upward to approximately ₹13,578 crore as investigations progressed. The fraud had been perpetrated over a period of nearly seven years through the systematic misuse of Letters of Undertaking, which are bank guarantees enabling an importer to obtain short-term credit from overseas branches of Indian banks or foreign banks. Nirav Modi, his uncle Mehul Choksi, and their affiliated companies had obtained LoUs from PNB’s Brady House branch in Mumbai without paying the requisite cash margins, without their accounts being debited, and without any entry being made in the bank’s core banking system CBS. The LoUs were instead transmitted through the Society for Worldwide Interbank Financial Telecommunication  Swift messaging system, which was not integrated with the CBS at PNB, enabling dishonest bank officials to issue unauthorised guarantees that remained invisible to senior management and auditors.

The fraud was discovered only when Nirav Modi’s companies approached PNB seeking fresh LoUs after the retirement of the principal accused official, Gokulnath Shetty, a Deputy Manager who had been the linchpin of the scheme. When a new officer sought documentation and demanded margin money, the scheme unravelled. The Central Bureau of Investigation and the Enforcement Directorate registered cases, leading to the flight of Nirav Modi and Mehul Choksi from India before arrest warrants could be executed. Both individuals were subsequently located abroad, and extradition proceedings were initiated, with Nirav Modi arrested in London in 2019 and his extradition to India ordered by UK courts after prolonged litigation.

The PNB fraud raised questions that went far beyond the conduct of the individual accused. How could a scheme of this magnitude operate undetected for nearly seven years across multiple banking relationships? Why were Swift messages not reconciled with core banking records? How had internal audits, concurrent audits, statutory auditors, and RBI inspections all failed to detect the anomaly? What does this failure reveal about the regulatory culture governing public sector banks in India, and what institutional reforms are necessary to prevent recurrence?

Use of Legal Jargon

Letters of Undertaking and the Swift Disconnect — The Mechanical Architecture of the Fraud:

A Letter of Undertaking is a form of bank guarantee governed by the Foreign Exchange Management Act, 1999  FEMA  and the regulations framed thereunder, as well as the Uniform Customs and Practice for Documentary Credits UCP 600 published by the International Chamber of Commerce for international trade financing instruments. Under RBI guidelines, LoUs were a recognised instrument for facilitating import financing and were subject to prudential norms including mandatory cash margins, limits on tenor, and disclosure requirements in the bank’s books. The critical failure at PNB was the absence of integration between the Swift messaging infrastructure used to communicate LoUs to overseas banks, and the Core Banking System in which all authorised transactions were required to be recorded. RBI had issued circulars requiring banks to integrate Swift with CBS, but compliance was not uniformly enforced, and PNB’s Brady House branch exploited this gap for years.

Prevention of Money Laundering Act and Proceeds of Crime:

The Enforcement Directorate proceeded against Nirav Modi, Mehul Choksi, and their associates primarily under the Prevention of Money Laundering Act, 2002 PMLA. The PMLA defines “proceeds of crime” under Section 2(u) to mean any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence. The predicate offences under the Indian Penal Code, 1860 specifically Sections 420 — cheating, 467 and 468 forgery, and 471 using forged documents as genuine triggered the PMLA’s attachment and confiscation jurisdiction. Attachment orders were issued against immovable properties, luxury goods, jewellery, and bank accounts of the accused, and the Adjudicating Authority under the PMLA confirmed attachments running into thousands of crores.

Banking Regulation Act and RBI’s Supervisory Jurisdiction:

The Reserve Bank of India exercises supervisory jurisdiction over scheduled commercial banks under the Banking Regulation Act, 1949. Section 35 of the Act empowers RBI to conduct inspections of banks, and Section 36 confers directions-issuing power. The RBI’s Annual Financial Inspection of PNB for the relevant years ought to have identified the Swift-CBS disconnect, the issuance of LoUs without margin or CBS entries, and the concentration of contingent liability in a single branch officer. The failure of RBI’s inspection mechanism to detect the fraud over multiple inspection cycles drew intense criticism and led to the central bank issuing a master direction in April 2018 mandating the integration of Swift with CBS across all scheduled commercial banks within a defined timeline. The episode also raised questions about the adequacy of the Risk-Based Supervision framework that RBI had adopted to replace the earlier compliance-based inspection model.

Corporate Governance and the Companies Act, 2013:

Nirav Modi’s corporate entities Firestar International, Firestar Diamond International, and affiliated companies were governed by the Companies Act, 2013. Investigations revealed that the corporate governance structures within these entities were subverted to facilitate the fraud: the proceeds of the fraudulent LoUs were deployed to fund international diamond trading operations, with intragroup transactions used to obscure the trail of funds. The serious fraud investigation office SFIO was constituted to investigate the corporate entities. The episode highlighted the inadequacy of statutory audit mechanisms under the Companies Act for detecting sophisticated interbank fraud where the principal misrepresentation occurred at the banking level rather than in the corporate accounts.

The Proof

The scale of the PNB fraud and its systemic implications are supported by empirical data drawn from parliamentary proceedings, regulatory disclosures, and judicial records. As of the final charge sheet filed by the CBI, the total quantum of fraud was established at approximately ₹13,578 crore among the largest bank frauds in Indian history at the time of its disclosure. The CBI registered two First Information Reports and filed charge sheets before the Special CBI Court in Mumbai naming Nirav Modi, Mehul Choksi, Gokulnath Shetty, and several other accused.

The Parliamentary Standing Committee on Finance, in its report presented in 2018, examined the circumstances of the fraud and noted that RBI’s supervisory framework had failed to detect the Swift-CBS disconnection despite repeated inspection cycles. The Committee recommended mandatory integration of messaging and banking systems, enhanced whistleblower protections for bank employees, periodic rotation of officials handling sensitive transactions, and greater accountability for statutory auditors. The RBI’s own internal enquiry acknowledged that inspection teams ought to have flagged the absence of Swift-CBS reconciliation and that the risk-based supervision model required recalibration.

The Enforcement Directorate attached assets worth more than ₹1,900 crore in the first phase of proceedings, with subsequent attachments covering properties in India and abroad. The extradition proceedings against Nirav Modi in the United Kingdom, which culminated in a judgment by the Westminster Magistrates’ Court in February 2021 ordering extradition, and the subsequent appellate proceedings in the High Court and the Supreme Court of the United Kingdom, generated a detailed judicial record of the fraud’s mechanics and the evidence assembled by Indian investigative agencies. The UK courts’ decisions affirmed the gravity of the allegations and rejected the fugitive’s mental health-based arguments against extradition. As of the knowledge available at the time of writing, extradition proceedings were ongoing through the UK appellate process.

Beyond the PNB case, the RBI’s Annual Report for 2017–2018 disclosed that fraud cases in the banking sector above ₹100 crore had increased substantially in number and quantum over the preceding decade, pointing to structural rather than episodic causes. The total amount involved in large-value frauds reported by scheduled commercial banks in the year immediately following the PNB disclosure stood at approximately ₹71,500 crore, reflecting both fresh cases and the delayed reporting of older frauds that the regulatory crisis had catalysed.

Case Laws

Nirav Modi v. Westminster Magistrates’ Court — High Court of Justice, Queen’s Bench Division, 2021

The High Court of Justice in England dismissed Nirav Modi’s appeal against the extradition order issued by the Westminster Magistrates’ Court. The Court held that there was a strong prima facie case against the accused based on the evidence of fraudulent LoU issuance, misuse of the Swift system, and the quantum of funds diverted. The Court rejected submissions that trial conditions in India would violate the accused’s Article 3 rights under the European Convention on Human Rights and found the Indian judicial system capable of conducting a fair trial. The judgment is significant as an international judicial affirmation of the integrity and sufficiency of India’s evidentiary case in this fraud.

Enforcement Directorate v. Nirav Modi — PMLA Proceedings, Adjudicating Authority

The Adjudicating Authority under the PMLA confirmed attachment orders in respect of properties including residential premises in Mumbai, jewellery, luxury goods, and shareholding interests in companies associated with the accused. The Authority held that the proceeds from the fraudulent LoUs constituted “proceeds of crime” under Section 2(u) of the PMLA, that the predicate offences under the IPC were established, and that the attachment was justified to preserve assets pending trial. The proceedings established the legal basis for confiscation and provided a significant deterrent signal regarding asset-stripping by fugitives.

Punjab National Bank v. State of Maharashtra — Bombay High Court, Bank Recovery Proceedings

PNB initiated recovery proceedings before the Debt Recovery Tribunal DRT Mumbai, against the entities and guarantors associated with the fraudulent LoUs. The proceedings raised complex questions about the liability of overseas banks that had extended credit on the basis of PNB’s LoUs without independently verifying the underlying trade transactions. The DRT proceedings and ancillary challenges before the Bombay High Court clarified the contractual and tortious framework applicable to losses arising from unauthorised banking communications, the respective rights of the issuing and negotiating banks, and the scope of the Limitation Act in respect of claims flowing from discovered fraud.

In Re: Fugitive Economic Offenders Act, 2018 — Various Proceedings

The Fugitive Economic Offenders Act, 2018  FEOA was enacted in direct legislative response to the flight of Nirav Modi, Mehul Choksi, and Vijay Mallya from India. The Act, upheld by the Supreme Court in its constitutionality, enables the designation of a person as a Fugitive Economic Offender upon satisfaction of specified criteria and permits confiscation of the offender’s properties in India and abroad without criminal conviction, on application by the Enforcement Directorate to a designated Special Court under the PMLA. Nirav Modi and Mehul Choksi were declared Fugitive Economic Offenders, and their properties were subjected to confiscation proceedings. The Act represents a significant expansion of India’s asset recovery toolkit in response to the vulnerabilities exposed by the PNB fraud.

Conclusion

The PNB scam was a watershed event in Indian banking because it exposed how a surprisingly simple fraud could bypass multiple layers of audit and RBI inspection for seven years by exploiting a disconnect between two internal communication systems. While the subsequent regulatory response successfully plugged these technical gaps forcing SWIFT-CBS integration, banning Letters of Undertaking (LoUs), and strengthening economic offender laws the deeper structural vulnerability remains unaddressed. The fundamental conflict between government ownership and RBI regulation creates an environment of diffuse accountability and political interference. Until public sector bank boards are genuinely insulated from executive government meddling and the RBI’s supervisory independence is constitutionally secured, the underlying culture of concealment will persist, leaving the banking system exposed to endemic risk.

FAQs

Q1. What exactly was the PNB scam and how did it work?

The PNB scam involved the fraudulent issuance of Letters of Undertaking — essentially bank guarantees for import financing — by officials at PNB’s Brady House branch in Mumbai. These LoUs were transmitted through the Swift interbank messaging system without being recorded in the bank’s core banking system, meaning they were invisible to auditors and senior management. Overseas banks provided credit to Nirav Modi’s companies based on these LoUs, and when the companies defaulted, PNB was liable. The scheme operated from approximately 2011 to 2018 and involved approximately ₹13,578 crore in fraudulent guarantees.

Q2. What legislative changes did the PNB fraud prompt?

The PNB fraud directly prompted the enactment of the Fugitive Economic Offenders Act, 2018, which enables confiscation of properties of persons who flee India to evade prosecution in economic offences. The RBI issued a master direction mandating Swift-CBS integration and subsequently banned LoUs for most import financing purposes. The PMLA was amended to strengthen attachment powers. The Ministry of Finance and RBI also issued revised guidelines on concurrent audit, fraud reporting timelines, and whistleblower protections within banks.

Q3. What is the current status of the extradition of Nirav Modi?

Nirav Modi was arrested in London in March 2019. The Westminster Magistrates’ Court ordered his extradition in February 2021. Nirav Modi appealed to the High Court of Justice, which dismissed his appeal. Further appeals through the UK court system have prolonged the proceedings. As of the time of writing, extradition had not been finally executed and appeals remained pending in the UK. Mehul Choksi, located in Antigua and Barbuda, has also been the subject of extradition proceedings involving multiple jurisdictions.

References (Optional)

1.  Prevention of Money Laundering Act, 2002, Sections 2(u), 3, and 5.

2.  Banking Regulation Act, 1949, Sections 35 and 36.

3.  Fugitive Economic Offenders Act, 2018.

4.  Foreign Exchange Management Act, 1999 and FEMA (Guarantees) Regulations, 2000.

5.  Reserve Bank of India, Master Direction on Swift Related Operational Controls, April 2018.

6.  Reserve Bank of India, Circular discontinuing Letters of Undertaking and Letters of Comfort for Trade Credit, March 2018.

7.  Central Bureau of Investigation, Charge Sheet in RC Case No. 45(A)/2018.

8.  Parliamentary Standing Committee on Finance, Report on Non-Performing Assets and Bank Frauds, 2018.

9.  Nirav Modi v. Government of India, High Court of Justice, Queen’s Bench Division, 2021.

10.  P.J. Nayak Committee, Report of the Committee to Review Governance of Boards of Banks in India, 2014.

11.  Reserve Bank of India, Annual Report 2017–2018.