Journal of Forensic and Investigative Accounting

Volume 11: Issue 2, Special Edition, 2019

Gem of the Indian Banking Fraud: A Case of Systemic Control Failures at Punjab National Bank
Gagan Kukreja
Sanjay Gupa*

Introduction
Punjab National Bank (PNB) is one of the largest public sector banks in India. The government owns 65.01% of its equity
as on March 31, 2017 (PNB, 2017). According to Top Banker 2017 report of Dun and Bradstreet (2017, p 107), the PNB
ranks third among all Indian banks and second among the Indian public sector banks in terms of business size (total of
advances and deposits), which exceeds USD 160 billion as of March 31, 2017. The core strengths of the bank are its brand
image with 122 years of experience, its more than 100 million customers, its strong deposit base, its consistently growing
operating profit, and its low cost of operations, and its extensive rural and urban branch network, stable asset quality and
rapid digitalization. As on March 31, 2017, PNB had an aggregate asset size of USD 111 billion, equity of USD 6.5 billion
and net income of USD 204 million. The banks total capital ratio (regulatory capital to risk weighted assets) was close to
twelve percent (PNB, 2017).
Before we delve into the details of the PNB fraud, we need to understand how the trade is financed by banks in India. Some
frequently used terms in import-export finance are explained below.
Letter of Undertaking (LoU) and Foreign Letter of Credit (FLC) (“hundi” in Hindi)
A LoU is a letter of guarantee issued by a bank on behalf of its customers to foreign branches of other banks, who offer
credit to these customers. A FLC is a guarantee from a bank that a particular seller based in a foreign country will receive a
payment due from a particular buyer within a specified time period. The key difference between a LoU and a FLC is that
an LoU cannot be discounted unlike a FLC. A LoU does not require the releasing of documents by the issuing bank. The
credit risk exposure in a LoU is to the issuing bank and not to the buyer/seller of goods. LoUs and FLCs are “a contingent
liability” from the accounting point of view of the bank. This means that a liability may or may not arise, depending on the
outcome of a specific event. These contingent liabilities are disclosed in the financial statements or in the notes to the
financial statements in the annual report depending on the probability of default and reasonable estimates. Inasmuch as
being document credits, which equal the amount mentioned, that potentially expose the bank to substantial liability, LoUs
and FLCs require approval of senior management of the bank. Generally, banks retain adequate security (depends on the
creditworthiness of the customer) as collateral before issuing LoUs or FLCs.
Nostro/Vostro Account
A nostro account is an account of a local bank held with a foreign bank, usually in the currency of the foreign bank’s country.
A vostro account is an account that a correspondent bank holds on behalf of another bank. For example, in the case of PNB,
the PNB’s USD account with Standard Chartered Bank in Hong Kong is a nostro account for PNB. The same account is a
vostro account for Standard Chartered Bank.
Society for Worldwide Interbank Financial Telecommunications (SWIFT)
SWIFT uses a standardized proprietary communications platform, such as Telex or WhatsApp, to facilitate the transmission
of information, including payment instructions, among 11,000 financial institutions in 200 countries. SWIFT neither holds
funds on its own, nor manages external client accounts. Financial institutions issue LoUs and FLCs through the SWIFT
platform.

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*The authors are, respectively, professor at Ahlia University and Head of Reserve Risk Control at Central Bank of Bahrain.
 Journal of Forensic and Investigative Accounting
Volume 11: Issue 2, Special Edition, 2019

Core Banking Solution (CBS)

CBS is a networking of branches which enable customers to use their accounts and avail of banking services from any
branch of the bank in the CBS network, regardless of where the customer maintains his or her account. The customer is no
longer a customer of just one branch. He or she becomes the bank's customer. PNB was using Finacle software developed
by the Indian IT giant Infosys.
Why are LoUs or FLCs Used in International Trade Finance?
The Indian rupee ₹ is not a fully-convertible currency on a capital account. As per the current Reserve Bank of India (RBI)
regulations, the maximum amount anyone can remit outside India in foreign currency is capped at USD 250,000 (RBI
circular, 2016). This means that no Indian resident can buy or sell foreign currency in the open market beyond this amount.
Accordingly, whenever an importer needs foreign currency to pay for imports, he or she has to go to the bank and apply for
funds in a foreign currency. The importer has two options to obtain foreign currency funds from a bank in India. The first
option is to obtain a foreign currency loan, which involves a time consuming, tedious and expensive process and the second
option is to obtain a bank guarantee, which involves a relatively less expensive and faster process. Naturally, importers
generally opt for the second option and request their banks to issue LoUs or FLCs, akin to bank guarantees.
Background of Alleged Fraud at PNB
On January 29, 2018, PNB, filing a complaint with the Central Bureau of Investigation (CBI) (Federal Investigation Agency
of India), alleged that Nirav Modi, Ami Modi, Nishal Modi and Mehul Choksi, all partners of Diamond R US, Solar Exports
and Stellar Diamonds (all non-issuer companies), in collusion with two bank officials, committed fraud against PNB.
Furthermore, they informed the CBI that at the bank’s office at Brady House in Fort, Mumbai, two of its employees,
Gokulnath Shetty, retired Deputy Manager of PNB, and another official Manoj Kharat, issued fraudulent LoUs worth ₹
2,807 million (about USD forty-three million) in 2017 to Hong Kong-based creditors on behalf of three firms associated
with Nirav Modi and the Gitanjali Group (issuer company) (The Daily Pioneer, 2018). On February 14, 2018, within two
weeks of the above complaint, the PNB filed a stock statement with Bombay Stock Exchanges maintaining that “The Bank
has detected some fraudulent and unauthorized transactions (messages) in one of its branches in Mumbai for the benefit of
a few select account holders with their apparent connivance. Based on these messages, other banks appear to have advanced
money to these customers abroad. In the bank, these transactions are contingent in nature and (any) liability arising out of
these on the bank shall be decided based on the law and genuineness of underlying transactions. The quantum of such
transactions is about ₹ 114,000 million (about USD 1771.69 million), which is almost one-third of the net worth of the bank.
The matter (has) already (been) referred to law enforcement agencies to examine and book the culprits as per (the) law of
the land” (Krishna, 2018).
In response to this disclosure, the stock price of PNB nose-dived. Various law enforcement agencies started an investigation
of the alleged fraud and the Institute of Chartered Accountants of India (ICAI) commenced an investigation of the integrity
of PNB’s auditors. Subsequently, several officers of PNB, charged with fraud, were arrested.
The total amount of the fraud equates to forty-nine times that of the net profit posted by PNB for the quarter ending
December 31, 2017, and exceeds, by more than twice over, the amount that PNB received from the government of India
under bank recapitalization plans (₹ 54,730 million) during the financial year 2017–18. According to a statement issued by
the Ministry of Finance (MOF), PNB had issued as many as 41,178 LoUs since 2011, of which 1,590 were given to Nirav
Modi, Mehul Choksi and their associates (The Hindu Business Line, 2018).
This is not the first time that PNB had incurred huge losses due to employee-perpetrated fraud. In 1985, a general manager
of PNB’s London Branch was arrested for alleged connivance in granting loans worth over ₹ 2,500 million without sufficient
securities (Chawla, 2014). In August 2016, three officials of the Chandigarh branch of Indian Overseas Bank (IOB) were
prosecuted for fraudulently issuing LoUs that incurred a loss of ₹ 3210 million (about USD fifty million) on IOB, PNB and
the Bank of Baroda (BOB) (Ahmed, 2016). As per information obtained under the Right to Information Act (RTI), due to
fraud, the PNB has cumulatively lost ₹65,620 million (about USD 1,000 million) in 389 cases in the five years ending March
31, 2017 (The Hindustan Times, 2018). A consortium led by Standard Chartered Bank had lent ₹ 68,000 million to The
Winsome Diamond Group with PNB bearing the highest exposure of any single bank in the syndicate at ₹ 18,000 million.
The loans were taken by three group companies: Winsome Diamond and Jewelers, Forever Precious Diamond and Jeweler,
and Suraj Diamonds (Business Today, May 22, 2018).

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 Journal of Forensic and Investigative Accounting
Volume 11: Issue 2, Special Edition, 2019

The Alleged Orchestrators of the PNB Scandal

Nirav Modi, born in India and raised in the Belgian city of Antwerp, the world's diamond capital, is a third generation
diamantaire. According to Forbes, Wharton-dropout Nirav Modi has a net worth of USD 1.73 billion. He is said to have
developed his business acumen in the diamond trade under the stewardship of his maternal uncle, Mehul Choksi, who is
also the CMD of the popular jewelry brand Gitanjali Gems. In 2010, Modi became the first Indian jeweler to be featured on
the cover of Sotheby's and Christie's auction catalogues. He was featured among Forbes’ 100 richest Indians list in 2017.
Nirav Modi, his wife Ami Modi (a U.S. citizen), brother Nishal, and Mehul Choksi are partners in Diamonds R US, Solar
Exports, and Stellar Diamonds, which has shops in foreign locations, such as Hong Kong, Dubai, and New York. The Nirav
Modi store in New York shares space with legendary brands, such as Chanel, Hermes, Prada, and Gucci. The store launch
was graced by celebrity guests, such as then U.S. presidential contender Donald Trump, the Hollywood actress Naomi Watts,
the Indian actress Priyanka Chopra, and the leading model Coca Rocha. Subsequently, Nirav Modi opened stores in London,
Hong Kong, and Macau.
Mehul Choksi is an Indian businessman and the owner of Gitanjali Group, a retail jewelry company with 4,000 stores in
India. He was allegedly involved in a stock market manipulation in 2013 (Srinivas and Ghosal, 2013).
How the Fraud was Uncovered?
On May 31, 2017, Gokulnath Shetty who was allegedly involved in fraudulent LoUs, retired from PNB, having worked at
the Brady House branch for nearly seven years, despite RBI’s guidelines stating that staff should rotate every three years
(Quora, 2017). PNB initially discovered fraudulent LoUs guarantees, some apparently used to pay off older loans coming
due on January 16, 2018, when a representative of Modi’s firm sought a new LoU to support further overseas borrowing.
“They wanted the process to continue”. “But the old employee was not there, and the new ones said no to these practices”.
Scrutinizing the bank’s records, including old SWIFT messages, the new bank employee uncovered the full scale of the
problem, leading to a stunning stock exchange announcement on February 14, 2018. Nirav Modi, Mehul Choksi, and their
families had already left India in early January 2018, just days before the first of Choksi’s many LoUs from the previous
year came due (Dubey, 2018).
PNB’s Brady House Fort Mumbai branch, where the fraud took place, is a mid-size corporate branch that can give credit
up to ₹ 500 million (around USD 7.5 million). Such branches are generally headed by an Assistant General Manager (AGM).
Following Figure 1, a typical organizational hierarchy in a public sector bank shows the position of AGM in the overall
management structure of the bank.
Figure 1: Organizational Hierarchy of Public Sector Bank of India
MD
and
CEO
Executive
Director
General
Manager
Deputy General
Manager
Assistant General
Manager
Chief Manager
Senior Manager
Manager
Officer
Subordinate/Clerical Staff

(Source: Created by the authors)

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Volume 11: Issue 2, Special Edition, 2019

Out of more than 6,000 branches, PNB has only twenty-five large- and medium-sized corporate branches, including the one
at Brady House, where the fraud took place. Notwithstanding that such branches are subjected to a higher level of managerial
control, regulatory oversight and supervisory review than smaller branches, fraud of this magnitude nonetheless remained
undetected for more than seven years.
What Was the Fraud’s Modus Operandi?
There were two types of fraud that took place at PNB. In the first type, Nirav Modi, Mehul Choksi, and their companies
secured LoUs without proper authorization and without collateral colluded with officials from PNB’s Brady House branch
in Mumbai in the issuance of fraudulent LoUs. In the second type, FLCs were issued to importers (Nirav Modi and Mehul
Choksi) for importing diamonds. The value of these FLCs was later modified and recorded in SWIFT and in FLC documents
at a higher value than the actual amount posted in PNB’s CBS. These LoUs and FLCs were used to obtain loans abroad
ostensibly to pay for imports. According to investigators, the two submitted forged papers related to imported jewelry. Once
the funds were released to suppliers overseas, the suppliers, believed to be fronts for Nirav Modi and Choksi group firms,
promptly sent the money back to India into accounts of shell firms owned by the duo through fictitious transactions.
Investigations have revealed that the companies involved in the transactions abroad were bogus firms with their directors
having been previously employed by Nirav Modi and Mehul Choksi. Two firms Firestar Diamond and Gitanjali Gems
laundered the misappropriated funds (Singh, 2018). Investigators have discovered that, in many instances, Choksi brought
money from overseas into the account of his company Gitanjali Gems. He subsequently diverted these funds into accounts
of various dummy (shell) companies describing the transfers as unsecured loans, from where money was siphoned off
through various means, including cash withdrawals. Most of the twenty dummy firms are based in Hong Kong and Dubai.
Investigators found that of the ₹ 123,000 million, Nirav Modi was responsible for transactions amounting to ₹ 65,000 million,
while the remaining ₹ 58,000 million belonged to Mehul Choksi. According to the RBI rules, the validity of a LoU is ninety
days from the day of shipment. However, the foreign branches loaned money against the LoUs, for a year in violation of
the RBI’s guidelines (Money Control, 2018).
Figure 2: Modus Operandi of PNB’s Fraud

(Source: Created by the authors)

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Volume 11: Issue 2, Special Edition, 2019

Nirav Modi and Mehul Chowksi (the duo) firms approach PNB India for issuance of LoUs in their favor. PNB India issue
the LoUs in favor of firms owned by the duo. The LoUs issued from PNB India are unauthorized and communicated to the
overseas banks on SWIFT system. The overseas banks, on the basis of LoUs issued from PNB India, provide loans to PNB
India and transfer money in PNB’s Nostro accounts overseas. From PNB’s Nostro accounts payments are made to the duo’s
foreign suppliers. Most of these foreign suppliers are shell firms of the duo which transferred money back to India through
fictitious transactions in different companies owned by the duo. The LoUs issued from PNB India are used to partly clear
the previous dues and remaining for fresh loans to firms owned by the duo. This circular rotation of unauthorized LoUs
went on until it was finally detected in February 2018.
Why the Fraud was Not Detected for so Long?
Banks in India are highly regulated by regulatory agencies, such as the MOF, the RBI, and the Securities and Exchange
Board of India (SEBI), in accordance with the Stock Exchange Listing Regulations, Banking Regulations, and Foreign
Exchange Management Act (FEMA). Perusal of PNB’s annual reports reveals that the bank’s internal controls include a
credit audit and review, an internal audit, an IT audit, a management audit, a compliance review and a vigilance review.
This is in addition to statutory audits, concurrent audits, tax audits, RBI inspections, FEMA audits and many more special
purpose audits. Furthermore, there are various committees of the board, such as the Risk Management Committee, the IT
Strategy Committee, the Special Committee of the Board for Monitoring Fraud Cases and the Audit Committee (PNB
Annual Report, 2016, and 2017).
LoU guarantees were issued on the SWIFT messaging system. SWIFT requires a maker-verifier-approver chain control in
place. Separate individuals with separate passwords are required to process the LoU; however, it is evident that the various
checks and authorizations (if at all) had been completely compromised. The maker, verifier, and approver worked in
collusion. The maker had access to all the passwords. There was no link or interface between CBS and SWIFT. The SWIFT
transactions were not captured as banking transactions in CBS unless manually entered into CBS or vice versa. There was
no rotation or transfer of staff at the SWIFT desk for almost eight years. No LoUs related documentation was retained at
the bank and all documents were returned to the client, against banking rules. An LoU allowed the customer, Nirav Modi
and his associates, to raise money from other Indian banks’ foreign branches (Allahabad Bank, Bank of India, United Bank,
State Bank of India, and Axis Bank) in the form of a short-term credit to pay offshore suppliers in foreign currency. By
rolling over credit, Nirav Modi had ensured that subsequent LoUs repaid the cash due on earlier LoUs, similar to a round
tripping process, akin to a Ponzi scheme. No default resulted until January 2018. Initially, LoUs with small dollars amount
proliferated but, gradually, the amount and number of LoUs increased. It also appears that the reverse confirmation process
of LoU was also compromised.
The buyer’s credit was discounted by the bankers without any counter verification by the issuing branch. Indian banks
continued discounting FLCs, for almost eight years, without suspecting any malfeasance with respect to a multitude of
amendments to these FLCs. The bank never questioned why all amendments were effectuated only through SWIFT. The
banks engaged in no other communications (Yadav, 2018).
The PNB Treasury Department’s daily reconciliation process overlooked the nostro accounts’ LoUs and FLCs. Apart from
this daily monitoring process, moreover, management’s monitoring, the credit monitoring, internal audits, special audits,
statutory audits and RBI inspections collectively failed to detect the alleged multi-year fraud.
In spite of an elaborative internal control and oversight mechanism in place, the issuance of unauthorized and fraudulent
LoUs continued and remained undetected for more than seven years. Apparently, it is a case of systemic failure. Responsible
authorities failed to adhere to the checks and balances that were put in place to provide fail-safes to undergird the integrity
of the regulatory processes. It is still an open question whether senior management was aware of the fraud or not.
Why the Auditors were Unable to Detect the Fraud?
Internal audits overlooked reconciliation of SWIFT transactions involving FLC and LoU guarantees with the transactions
recorded in the bank’s CBS. No red flag was ever raised by IT auditors for the non-integration of SWIFT and the CBS.
External auditors did not verify the authenticity of messages pertaining to financial transactions in the SWIFT MT700 series.

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The entries of inward and outward remittances that are done through the nostro account have to be recorded in the books of
the bank (a nostro mirror account). In the event that this did not happen, an audit process, which requires reconciliation of
the two accounts, should have uncovered these anomalies. Apparently, the reconciliation of entries in the nostro account
statement with those in the nostro mirror account of the bank did not happen.
According to the guidance note on bank audits issued by the ICAI, the auditor has to determine whether a system of
periodical reconciliation is in place and whether confirmations from the foreign banks are obtained on a periodic basis,
through physical confirmations, SWIFT messages, emails, etc. Initial investigation observed this practice was compromised
at auditors’ end (Guidance Note on Bank Audit, 2018).
External auditors of branches, as well as these at the head office of the bank, are required to submit a Long Form Audit
Report (LFAR) in addition to their regular statutory audit report on the accounts of the branch/bank. This LFAR requires
the auditors to answer specific questions on the internal control system/processes in place in the audited entity, be it in the
branch or other offices of the bank including the head office. One of the areas of reporting in the LFAR is bank
reconciliations and nostro balances. It is highly unlikely that external auditors missed this important area during the course
of their audit which mandates that they specifically report on it (Tax Guru, 2018).
Currently investigation is still in progress and insufficient information is available in public domain about the extent of the
negligence or collusion on the part of the auditors or the bank’s management that might contribute to an understanding of
why this fraud remained undetected for so long. However, it can be tentatively surmised that this fraud is attributable to a
failure of operational risk management and internal controls.
Early Warning Signs Ignored
The PNB fraud could have made headlines over a year ago. In July 2016, Bangalore-based entrepreneur, Hari Prasad had
written to the Prime Minister’s Office (PMO) drawing the attention of the authorities to what he thought could lead to a
huge fraud. Prasad had filed a First Information Report (FIR) with the Central Police Station in Bangalore from where the
matter eventually reached the CBI. The PMO forwarded the complaint to the Registrar of Companies (ROC) to look into
the matter. However, the ROC in its email to Hari Prasad replied that his grievance had been “disposed of” (Ranipeta, 2018).
The senior management of PNB "misrepresented" the factual position on LoUs to the RBI and ignored its warnings when
credit facilities worth over USD 2 billion were fraudulently cleared by its branch in Mumbai. PNB’s then MD and CEO
Usha Ananthasubramanian and her top officials also failed to prevent the fraud, despite having previous knowledge of the
modus operandi. Ms. Usha was the MD and CEO of PNB when a similar case of LoU fraud was reported from IOB,
Chandigarh, in 2016. Credits were issued by PNB's Dubai branch on the basis of these guarantees. The modus operandi in
the IOB case was similar to this of the Nirav Modi case. Hence, the senior management of PNB had presumably complete
knowledge of the methods used by fraudsters to cheat banks using LoUs. After the IOB fraud had surfaced, the RBI issued
guidelines and circulars to prevent such frauds from happening in banks. These guidelines were, apparently, not
implemented in PNB in their entirety (Business Today, February 16, 2018).
The RBI had sent a questionnaire to the officials seeking to know the status of the LoU issuing process in their bank. In
response, the PNB maintained that all was well in the bank. Senior officials of PNB did not implement the circulars and
caution notices issued by the RBI regarding safeguarding SWIFT operations, through which messages were sent to overseas
banks to issue loans to the companies of Nirav Modi. Reconciliations of CBS and SWIFT messages were not done, despite
repeated caution notices from the RBI. This oversight allowed then deputy manager of PNB’s branch to issue these
guarantees through SWIFT and bypass any scrutiny by the bank (Live Mint, 2018).
Aftermath of the Fraud
In as much as the INR 2.11 trillion recapitalization of PSU banks, planned prior to the discovery of massive fraud at PNB,
may be inadequate to stimulate lending and the growth (The Economic Times, October 27, 2017).
The RBI has further tightened reporting norms for Non-Performing Assets (NPAs) has adverse economic implications.
Stricter regulatory requirements effectuated by the RBI may make bank executives extremely cautious about issuing fresh
loans with the effect of further squeezing private investment, already rather tepid. Such will also lead to higher costs of
borrowing (Basu and Bawa, 2017).

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Lending instruments like the LoU, have been struck down by the regulator. The LoU ban is likely to hurt importers as well
as some exporters. If foreign trade weakens, the current account deficit will widen and increase the cost of government
borrowings. That, in turn, will strain public spending and the fiscal health. The rupee may weaken, fueling inflation (Nair,
2018).
Within days of the uncovering of fraud by the PNB management, the stock price of PNB nosedived from ₹ 161.65 on
February 13, 2018 to ₹ 75.60 on May 16, 2018, a decline of more than fifty percent shown in Graph 1:
Graph 1: Share Price Movement of PNB
250

200

150

100

50

0
1/1/2018 2/1/2018 3/1/2018 4/1/2018 5/1/2018

(Source: [Link], Accessed on May 1, 2018)

The stock price of Gitanjli Gems, the company owned by Nirav Modi and Mehul Choksi, declined from ₹ 62.85 on February
13, 2018 to ₹ 4.05 on May 15, 2018, a decline of more than ninety percent shown in Graph 2:
Graph 2: Share Price Movement of Gitanjali Gems
90

80

70

60

50

40

30

20

10

0
1/1/2018 2/1/2018 3/1/2018 4/1/2018 5/1/2018

(Source: [Link], Accessed on May 1, 2018)

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Various law enforcement agencies—including the CBI, Enforcement Directorate (ED), as well as the Income Tax
Department—started investigating the affairs of PNB to assign a responsibility for the massive fraud and to recover money
lost by the PNB (Chitravanshi and Tiwari, 2018).
The Ministry of Corporate Affairs (MCA) has ordered an investigation into the affairs of 107 companies and seven Limited
Liability Partnerships (LLPs) belonging to Nirav Modi and Mehul Choksi, to be carried out by the Serious Fraud
Investigation Office (SFIO) under the provisions of § 212(1)(c) of the Companies Act, 2013 and § 43(3)(c)(i) of the LLP
Act, 2008 (Narayan, 2018).
ED and CBI conducted raids at various premises of Nirav Modi and Mehul Choksi and seized assets valued at more than
USD 900 million. PNB fired eighteen of its employees and is currently considering legal action against some of them to
recover the monetary loss to the bank caused by their fraudulent actions (Chennabasaveshwar, 2018).
CBI arrested an internal auditor of the bank since he was "allegedly responsible for auditing the systems and practices" of
PNB’s Brady House branch and for reporting any problems to the regional audit office (The Economic Times, February 28,
2018).
The Disciplinary Directorate of the ICAI has issued Show Cause Notices to all Central Statutory Auditors of PNB. Similarly,
the Central Statutory Auditors who had done quarterly reviews of PNB have also been issued Show Cause Notices. The
auditor of Gitanjali Gems has also been issued a Show Cause Notice in the same matter. Further, the ICAI made a list of
the statutory auditors of the Brady House branch during 2011–12 and 2016–17 and asked them to appear before its Board
of Discipline (ICAI, 2018).
The Companies Act 2013 empowers the government of India to set up a new regulatory agency named National Financial
Reporting Authority (NFRA) to look into matters of professional or other misconduct and also to suspend Chartered
Accountants (CAs) and accounting firms from practicing for six months to ten years if found of guilty of fraud. The ICAI
has been strongly resisting this move of the government. The government of India has now approved draft rules that delimit
the NFRA’s jurisdiction and functions, of which the NFRA is shortly to be apprised (Ministry of Corporate Affairs, 2018).
The Government of India has dismissed Usha Ananthasubramanian as MD and CEO of Allahabad Bank on August 13,
2018. The President of India has granted sanction to prosecute Usha in the PNB case. Before moving to Allahabad Bank,
Usha headed PNB between August 2015 and May 2017. She was the executive director of PNB from July 2011 to November
2013 (The Economic Times, August 20, 2018).
Nirav Modi, his wife, his brother, and Mehul Choksi are on the run abroad. The CBI issued an Interpol notice against them.
Law enforcement agencies are investigating the role of other PNB’s senior management in the fraud.
Goldman Sachs downgraded its forecasts for India’s economy for the fiscal year 2018–19 to 7.6% from eight percent in the
wake of fraud at PNB, warning that it could spark tighter regulation of the banking sector, which in turn would constrain
credit growth (Srivastava, 2018).
Remedial Measures Undertaken
RBI has discontinued the practice of issuance of LoUs/FLCs for trade credits for imports into India. Importers can continue
to raise money via FLCs which have more international acceptance. FLCs involve more paperwork and the due diligence is
more stringent than this of LoU. Existing LoUs are to be phased out gradually (NDTV, 2018).
RBI has directed banks to reconcile transactions in nostro accounts on real time/near-real time basis, so that any abnormal
transaction is noticed immediately (Shukla and Das, 2018).
All banks have been required to ensure automatic linkage/interface between CBS and SWIFT by the end of April 2018.
RBI’s directive to banks to ensure that RBI’s rule of staff rotation after every three years is to be applied stringently
(Business Standard, 2018).
The Central Vigilance Commission (CVC) questioned senior PNB and RBI officials. RBI requested the MOF to have
control in the appointment of senior management and the board of directors in public sector banks (Tiwari, 2018).
Banks have put in place an additional layer of approval for outward SWIFT messages. Swift transactions are restricted to
being undertaken between 9:00 a.m. and 8:00 p.m. All SWIFT messages (financial transactions) are to be sent to the bank’s
centralized server and verified with CBS. Only then are the messages to be further transmitted (Hindu, 2018).
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Rules for issuing FLCs and bank guarantees have been tightened further in terms of augmentation of required documentation
and collateral (Hindu, 2018)
As per the statements of PNB’s non-executive chairman Sunil Mehta, PNB has further strengthening its internal control
processes, importing new technology, involving data analytics and artificial intelligence, into risk processes (Live Mint,
2018).
Conclusion and Recommendations
In hindsight, there are five major lessons for the banking sector from PNB’s LoU fraud:
Lesson 1: Follow the rule books—PNB could have stopped the fraud if it had followed the checks and controls in
place. In the PNB case, if the maker, checker, and authorizer control had been followed in the SWIFT messaging platform,
the fraud would not have taken place. A daily SWIFT report needs to be generated and monitored by senior management as
a standard practice.
Lesson 2: Overhaul risk management systems—PNB should be the trigger to overhaul the manner in which risk
management systems work within the Indian banking system. The risk management system in PNB failed to work with
respect to basic checks and balances. SWIFT and CBS of the banks are linked as instructed by the RBI (Source). Employees
must be transferred strictly as per the law, without any failure. Job rotation must be done every six months for each employee.
As in PNB’s case, Gokulnath Shetty was working in the same branch for more than seven years until he retired in May 2017.
Lesson 3: Importance of operational risk management—Banks need to better manage their operational risks. Credit
risk and market risk are related to potential losses from lending and investment activities, respectively. Losses occur in the
case of a loan default or if the value of an investment plummets. Operational risk indicates failure in banking systems,
processes or people (or any combination thereof). It has an impact on a broad range of products and businesses—in contrast
to credit risk or market risk, which affects specific transactions. Business managers are behaviorally inclined to emphasize
credit risk and market risk while short-shifting operational risk and compliance. In the PNB, magnifying operational risk,
gaping holes appeared in the process of checking a transaction before disbursing a non-funded loan.
Lesson 4: Skill development—Beyond banks, various agencies, such as the ICAI and the IIBF, as well as auditors
and regulators, need to improve their knowledge of the banking business. With the growing size and number of banking
institutions, complexities in business, the EU’s General Data Protection Regulations (2018) and the heavy use of IT, auditors
also need to make use of emerging technologies including, but not limited to audit management software, big data, block
chain technologies and data analytics in their audit processes. Adoption of audit management software facilitates
standardized processes, which, in turn, improve the quality and consistency of audits.
The RBI should also closely look at, and direct banks to take cognizance of, some of the points listed in the corporate
governance report submitted by the Kotak Committee to the SEBI. In an effort to facilitate a better understanding of, and
proactive management with respect to, banks’ risks, bank boards must possess modern and sophisticated risk management
expertise. Furthermore, boards, rather the CEOs, must appoint concurrent auditors to avoid potential conflicts of interest.
Lesson 5: Review of the disclosure and compliance framework—The government, in its policy-making capacity,
should evaluate the gaps in its policies leading to systemic failures. While any business is prone to failures, there should be
minimal scope for failures attributable to non-business risks. The MCA must review the reporting disclosure standards of
corporate entities, including banks. Rather than increasing the amount of compliance required in a knee-jerking fashion,
however, the MCA must holistically review the disclosure and compliance framework with a view to rendering it more
effective.
Were these lessons inculcated a decade ago, the trade finance fraud perpetrated against PNB would not have been feasible
or, in the alternate, would not have been sustainable over a multi-year period without detection. It is truism that, regardless
of banking ownership structure (public/private) or jurisdiction, scrupulous regulatory oversight, effective risk management
and vigilant internal control are vital to minimize the incidence of fraud. At the same time, however, it is incumbent on bank
staff to implement regulations, risk management and internal control in the day-to-day performance of their vocational tasks.
Apart from effective regulation, risk management and internal control, therefore, it is essential that bank staff understand
the serious consequences of bank fraud in all its possible manifestations and take full responsibility for the huge costs
involved in any acts of malfeasance and misfeasance on their part. Ultimately, bank staff must be cognizant that they are

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stakeholders in the banking system who assume the role of conscious stewards of bank assets and on whom it is incumbent
to thwart the perpetration of fraud by any rogue element in the future.
This fraud has similarities to many other frauds in banks like Wells Fargo and Citi Bank of the U.S. where the root cause
has been the delinquent behavior of employees. In those cases, it was found that the banks’ internal control and risk
management processes fail to capture this delinquent behavior early enough to minimize or avoid any losses.
Contribution of the Case
Maintaining integrity of trade finance is essential in emerging economies like India that have a major component of growth
driven by exports. Which rules, regulations and policies to put in place by the central banking authority are essential to
maintain this integrity? This case is especially relevant to other emerging economics that would behoove of lessons learned
in this case study to avert frauds of a similar nature. It delimits best practice in the issuance of LoUs and FLCs and the cost
to the banking system in particular and the economy in general when such practices are fLoUted. From this case, students
can gain perspective on the mechanics of trade finance through LoUs and FLCs and the legal and regulatory architecture
and audit controls needed for early and prompt detection of fraudulent transactions. It also instills in students the
indispensable role of bank staff as stakeholders in the banking system with their being enfranchised with stakes sufficiently
large to disincentive self-dealing.
Limitations of this Study
This case study is prepared for educational purposes based on secondary sources, all publicly available, such as newspapers,
magazines, websites, circulars of the RBI, and guidance notes of the ICAI. Neither co-author has access to confidential
information on PNB and other parties and entities under investigation. Nor have either co-author availed of primary sources
not having interviewed any party involved in the management of PNB, the audit of PNB, or any party or the investigator
charged with fraud. The evolution and unfolding of the PNB fraud are covered only until October 20, 2018. That
investigations are still on-going means that means that critical developments after that date, should they manifest, cannot
be included in this case study.

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Narayan K. 2018. ED-CBI raid Nirav Modi’s Mumbai house, seize jewelry, watches and MF Hussain’s paintings. The
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Case Requirements
Based on the following questions, write a report to the Board of Directors to help them understand what went wrong. Groups
of three to four students will be formed in class. Each group will be assigned one or more question to prepare a presentation
to the class.
Discussion Questions:
1. Internal controls are at the heart of any organization. Discuss the role of the senior management and the board of
directors to maintain effective internal controls. Offer any other proactive steps to be taken by the bank to make
internal controls more effective.
2. Discuss the modus operandi of the PNB fraud? Can technology, such as Blockchain, provide the solution to the
problem?
3. Critically evaluate the role of the auditors in banking operations? If internal controls were effective would the PNB
fraud be avoided?
4. Discuss the role of the regulators in setting effective controls for the bank? What recommendations can be offered
to regulators to avoid such frauds in the future?
5. Discuss the traits required of internal and external auditors for banking operations. What kind of recommendations
may be offered to the Institute of Chartered Accountants of India and the Institute of Banking and Finance in India
to make audit professionals more capable to conduct the audit and better address such bank fraud?

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