Author: Cheshta Vashishtha
College: Narsee Monjee Institute of Management Studies, Chandigarh
India’s banking and financial system has been tested on many occasions in the past by financial frauds which have revealed gaps in governance, regulatory supervisory framework and institutional accountability. The Harshad Mehta Securities Scam and Satyam Corporate Fraud were some of the most significant frauds of the year which changed the banking industry in India while the Punjab National Bank (PNB) Scam of 2018 rose to become one of the biggest banking scams ever to be discovered in India. The fraud not only resulted in an estimated loss of ₹13,000 crore to Punjab National Bank, but it also highlighted significant weaknesses in banking technology, internal controls, and risk management.
The PNB Scam was different from the usual banking fraud involving forged documents or unauthorized withdrawals as it was done using sophisticated methods: the Letters of Undertaking (LoUs) issued using the SWIFT (Society for Worldwide Interbank Financial Telecommunication) messaging system. The fraudulent transactions went undetected for several years as they were never booked in the bank’s Core Banking System (CBS). The wilful omission allowed foreign banks in India to provide huge credits to companies run by the diamond merchants, Nirav Modi and Mehul Choksi, without providing proper security or following banking guidelines.
The scam came to light in January 2018 and prompted nationwide worries on the integrity of India’s public sector banks. The Central Bureau of Investigation (CBI), Enforcement Directorate (ED) and Reserve Bank of India (RBI) investigations uncovered a well laid-out scheme with businessmen, bankers, shell companies and financial transactions with foreign entities. The entire scandal was followed by criminal charges, attachment of assets valued at thousands of crores, international extradition and fundamental changes in the banking and financial regulatory structure of India.
The PNB Scam not only had financial consequences, but also sparked legal issues related to the accountability for the crime, corporate governance, banking norms, money laundering, international collaboration, and regulatory responsibility. It is a landmark case that highlights technological loophole and institutional negligence that can be used to commit large scale economies crimes.
Background of the Scam
The Punjab National Bank was founded in 1894 and is one of the oldest and the largest public sector banks in India. The bank regularly provides international trade finance services through financial instruments like Letter of Credit (LoC) and Letter of Undertaking (LoU) due to the wide international and domestic activities it conducts. A Letter of Undertaking is a bank guarantee given by a bank’s branches in India for short-term buyer’s credit in imports. The issuance of an LoU involves proper sanction, maintaining proper Collateral, making a proper entry in the bank’s Core Banking System and adherence to the credit limit as per RBI guidelines. These protect and prevent the bank from becoming unaware of its contingent liabilities, and all transactions are referred to internal audit and regulatory supervision.
But from 2011 till 2017 these securities were systematically violated at the Brady House Branch of Punjab National Bank, Mumbai. The branch gave hundreds of LoUs for companies that were under the control of Nirav Modi and Mehul Choksi, including Diamond R US, Solar Exports and Stellar Diamonds, two officials of the branch are alleged to have done. Two officers of the branch, including Deputy Manager Gokulnath Shetty, allegedly issued hundreds of LoUs for firms under Nirav Modi and Mehul Choksi, such as Diamond R US, Solar Exports and Stellar Diamonds. The guarantees were sent to foreign branches of Indian banks like Allahabad Bank, Axis Bank, Union Bank of India, or State Bank of India using the SWIFT messaging system.
It was the intentional lack of recording these LoUs in the Core Banking System that was the critical part of the fraud. At the time, the guarantees did not appear in the official books of PNB, as SWIFT was not linked up with CBS. This meant there was no liability shown on the bank’s balance sheet, no collateral was taken from the borrowers, and successive LoUs were issued to settle past borrowings, and the fraud went undetected for many years.
The fraudulent scheme relied on active collusion by some bank officials that had access to SWIFT credentials and who knowingly ignored the banking procedures. The officials continued to stand in the branch’s vicinity and overseas banks kept continuing the loans based on false guarantees that they were actually from Punjab National Bank.
The scam started to fall apart in January 2018, as agents from the firms of Nirav Modi went to the branch for new LoUs. In contrast to the previous years, the new officials who were posted demanded collateral and asked for information about previous guarantees. Upon examination of the Core Banking System, no record of any previous LoUs could be found. This was a clear discrepancy which right away attracted suspicion and led to an internal investigation.
Further investigations confirmed that there had been numerous unauthorized SWIFT messages sent, leading to losses of almost ₹13,000 crore. Punjab National Bank notified the relevant and investigating agencies about the fraud and initiated the largest-ever financial crime investigation in India.
This disclosure of the scam was not only an exposure of individual acts of fraud but also an exposure of the institutional failures which allowed such frauds to occur. The fraud went undetected for nearly seven years due to the lack of adequate internal control, ineffective audits, insufficient technological integration, lack of supervisory oversight, and extended regulatory review.
The Modus Operandi: How the Fraud Was Executed
The Punjab National Bank Scam was not a one-off occurrence, but a well-planned fraud which took advantage of the flaws in the skills of the bank, the lack of internal controls and the deliberate collusion of the bank officials. Whereas fraudsters such as forgery of cheques or false loan applications are commonly applied fraud techniques with banking, this was a scam which was only applied with common banking methods and went undetected for almost 7 years.
The fraud was based around the misuse of Letters of Undertaking (LoUs). An LoU is a bank guarantee issued by one bank to another bank in favour of its customer to ensure repayment of short-term credit obtained by a customer for financing imports. As per the guidelines of the Reserve Bank of India, an LoU would be issued, only after checking the eligibility of the customer, adequate collateral, credit limits as sanctioned by the central bank, and entry in the Core Banking System (CBS) of the bank. These measures were meant to secure banks against the risk of incurring any liabilities by any unauthorised person and provide transparency in international trade financing.
But at their PNB’s Brady House Branch in Mumbai, such procedures were a no-go. Deputy Manager Gokulnath Shetty and another bank official Manoj Kharat allegedly issued LoUs to companies run by Nirav Modi and Mehul Choksi between 2011 and 2017. Rather than input these guarantees into their Core Banking System, they sent these guarantees directly via the SWIFT (Society for Worldwide Interbank Financial Telecommunication) network.
The SWIFT platform was not connected at the time to the bank’s Core Banking System. Therefore, banks overseas got a true impression of guarantees from the Punjab National Bank via SWIFT, but the liabilities were not recorded on the Punjab National Bank’s books. The transactions were not subject to routine audits, internal monitoring, and supervisory checks, since they were missing from the CBS.
Overseas branches of many Indian banks, such as Allahabad Bank, Axis Bank, Union Bank of India and State Bank of India, provided buyer’s credit to companies run by Nirav Modi and Mehul Choksi on the basis of these bogus LoUs. Later, investigators said a large share of the credit was instead channelledthrough a network of related companies and foreign entities for import business that wasn’t really conducted by the companies.
Since the earlier loans were due for repayment, new LoUs were provided to secure new credit and a new loan was used to pay off the previous ones. This made it a perpetual cycle of borrowing and a hidden financial exposure. The fact that each new LoU was issued away from the framework of the official banking system left PNB with no idea of the true size of its contingent liabilities.
The fraud was executed without any breaks until January 2018 when officials of the companies of the defaulter Nirav Modi went to the branch for a fresh Loan Letter of Authorisation (LoU). The officers who had until then had handled the transactions had retired or been transferred and the new officers demanded adherence to normal banking practices, including the provision of security. When the companies say that they had never asked for any collateral in the past, bank officials look into the Core Banking System and do not find any trace of previous guarantees. This mismatch immediately raised the awareness of unauthorised SWIFT transactions and an internal investigation was initiated.
Punjab National Bank then notified the authorities that the fraudulent LoUs had resulted in liabilities of nearly ₹13,000 crore, which at the time was the biggest banking fraud case in India. The complexity of the scam was a sign that the offense was no longer just about having forged documents, but more and more relied upon the manipulation of digital banking infrastructure. It also emphasized the need to incorporate technological systems into good governance, internal controls, and regulatory monitoring.
Investigation and Evidence
In January 2018, after the unauthorized transactions were uncovered, the Punjab National Bank (PNB) had informed the Central Bureau of Investigation (CBI) about the incident and filed a First Information Report (FIR) against Nirav Modi, Mehul Choksi, their associated companies and PNB officials. At the same time, the Enforcement Directorate (ED) launched investigations under the Prevention of Money Laundering Act, 2002 (PMLA) for tracing the money of the crime and identifying the assets acquired with the money allegedly laundered.
The investigation uncovered a significant amount of documentation and electronic evidence of the scheme. A major piece of evidence was the SWIFT transaction records which showed that many of the Letters of Undertaking had been sent to overseas banks but there was no record of such in the Core Banking System. This difference showed clearly that the normal banking methods had been intentionally ignored.
Investigators also looked at internal e-mail, access logs, banking documents, and digital authentication credentials of the officials who signed the LoUs. These records showed that certain staff were routinely involved in sending guarantees outside of the normal banking practice using their authorised SWIFT access. Bank personnel interviews confirmed claims of lengthy procedural abuses and internecine corruption.
These financial records during the investigation showed the flow of money through various entities in India and abroad connected with Nirav Modi and Mehul Choksi. The Enforcement Directorate said various shell companies were allegedly involved in making the funds flow from one location to another, making it difficult to identify their source and destination. The results of these findings were used as the basis for the proceedings in accordance with the Prevention of Money Laundering Act.
Large amounts of documents related to financial transactions, electronic devices, company records, inventories of jewellery, and business letters were found and seized during searches by investigative agencies. The Enforcement Directorate (ED) also provisionally attached movable and immovable assets, luxury vehicles, bank accounts, high-value jewellery, artworks and other items that were thought to be the fruits of crime. The total worth of such assets attached was in the thousands of crores of rupees.
The Indian authorities then requested support from several foreign countries using various avenues of international cooperation, including the MLATs. Banking details, financial records and help in determining assets outside India were demanded. The investigations spanned a wide range of countries, such as the United Kingdom, Belgium, Hong Kong, Singapore, United Arab Emirates and the United States, illustrating the international nature of the alleged fraud.
The investigation also revealed significant weaknesses in Punjab National Bank. Internal audits have not been able to identify the repeated SWIFT messages, the regulatorily procedures and mechanisms have proven to be inadequate, and the lack of integration between the SWIFT platform and the Core Banking System allowed fraudulent transactions to be conducted without hindrances over several years. The findings led the Reserve Bank of India to start far-reaching reforms focusing on improving banking supervision, technological security and minimizing risks in foreign trade finance.
Legal Issues, Judicial Proceedings and Lasting Impact
The Punjab National Bank Scam is one of the most important economic offence cases in India, which resulted in multiple criminal and civil cases. Nirav Modi, Mehul Choksi, their firms and some officials of the PNB were charged with offences under criminal conspiracy (Section 120B IPC), cheating (Section 420 IPC), forgery (Sections 467, 468, and 471 IPC) and criminal breach of trust. The bank officials were also charged and prosecuted under the Prevention of Corruption Act, 1988, for misuse of official power and taking of unauthorized transactions.
Under the Prevention of Money Laundering Act, 2002 (PMLA), the Enforcement Directorate (ED) has initiated parallel proceedings. The ED had claimed that the accused were involved in the laundering of the money of crime through various domestic and foreign companies and then used the movement of movable and immovable assets of thousands of crores of rupees, out of which luxury properties, jewellery, bank accounts and artworks were attached. Further, Nirav Modi was declared a Fugitive Economic Offender under the Fugitive Economic Offenders Act, 2018, paving the way for the payment of properties even after his illegal departure from India.
The case took an international turn as both Nirav Modi and Mehul Choksi had left India before the fraud came to light. In March 2019, Nirav Modi was arrested in the United Kingdom, and following extensive hearings, it was decided that he is eligible for extradition to India. However, his extradition is still subject to the exhaustion of legal remedies. In addition, Mehul Choksi, who took up Antiguan citizenship, has also been subject to extradition warrants and litigation in various jurisdictions, but has not yet been extradited to India.
The scam highlighted serious flaws in the Indian banking system, in addition to the conviction of the accused. The Reserve Bank of India (RBI) in return scrapped Letters of Undertaking (LoUs) and Letters of Comfort (LoCs) for trade credit, introduced full integration of SWIFT messaging system with banks’ Core Banking Systems, tightened internal audit processes and increased compliance norms in the case of international banking transactions. The public sector banks also implemented enhanced risk management measures, increased accountability of their staff and better cyber security and fraud control measures.
Conclusion
The Punjab National Bank Scam is a stark reminder of the potential for massive financial fraud through technological weaknesses, inadequate internal controls, and institutional oversight. It proved that once established banking institutions are still subject of vulnerabilities in the absence of effective governance/compliance controls. The reforms that were brought about after the scam have enhanced the Indian Banking Regulatory Regime to a great extent, but the legal proceedings are still ongoing. The case highlights the importance of transparency, accountability, strong technological controls and good regulatory practice in ensuring public trust in the financial system. Its influence is not just felt in the prosecution of the accused, but in the way economic crimes are tackled in India and also on the need for ethical corporate governance.
