Two bank frauds that came to light in the past month have exposed the weaknesses of multiple regulatory mechanisms which make it easy for unscrupulous businessmen to take state-owned institutions for a ride.
The central figure in one of the two fraud cases which the Central Bureau of Investigation is pursuing is “Diamond King” Nirav Modi (no relation of Prime Minister Narendra Modi), who has been on the Forbes list of billionaires since 2013. He slipped out of India with his family and his uncle Mehul Choksi, also a diamond merchant, in January before the public sector Punjab National Bank (PNB) lodged a complaint against them to the CBI.
He, however, turned up at Davos, Switzerland, to join the large delegation of businessmen which was with the Prime Minister at the World Economic Forum.
The other businessman in the spotlight is Vikram Kothari, promoter of a firm that makes a well-known brand of pens. The complaint against him was filed by the Bank of Baroda (BoB), which too is state-owned.
Vipul Ambani, president of one of Modi’s diamond firms, and Kapil Khandewal, CFO of a diamond firm owned by Choksi, and serving and retired PNB officials are among those whom the CBI has arrested. Vikram Kothari and his son Rahul are in custody in connection with the BoB case.
The PNB puts the amount involved in the dubious Modi transactions at Rs114 billion ($1.8 billion), making it the biggest bank fraud. The amount involved in Kothari’s allegedly fraudulent BoB deals is said to be about Rs 37 billion.
A farmer seeking a loan for agricultural purposes or a parent seeking a loan for his son’s higher education in India or abroad will be required to provide collateral security to cover the loan amount. On the basis of the bank’s assessment of the borrowers’ credit-worthiness, limits are set on the borrowing.
A billionaire seeking a loan to make business deals abroad has an easier route. He gets the bank to issue a guarantee, in the form of a letter of understanding (LoU), for cheap short-term foreign currency loans from banks abroad. Ordinarily the bank providing the guarantee secures from the borrower a fixed deposit, the return from which will be higher than the amount of the foreign loan.
Nirav Modi is reported to have secured loans from about 35 foreign branches of various Indian banks using PNB’s LoUs in the last seven years. As the guarantor, PNB has to reimburse the lending banks in case the borrower defaults.
PNB officials issued LoUs to Modi’s firms without obtaining collateral in some form. Ignoring the Reserve Bank of India’s directive to limit the validity of LoUs to 90 days PNB issued documents with a year’s validity.
The investigations so far indicate that Modi used an LoU of 2011 to raise money from banks abroad to buy diamonds. On selling the diamonds, he was required to remit to PNB the money he owed to the lending banks. He did not do so. Instead he siphoned it off the money to build assets and obtained a fresh LoU and raised more loans with it. Part of the money so raised was used to pay off the old loans.
The process went on for seven years without being detected. Since all previous loans were repaid with interest when new loans were raised, on the PNB’s books he looked like a good customer who promptly paid the dues. It did not get wise to his modus operandi until the loan amount reached the whopping figure of Rs114 billion.
Ten days ago, the Enforcement Directorate said it had seized diamonds and other valuables worth more than Rs57 billion in raids on firms owned by Modi and Choksi. The raids were said to be continuing at that time but no figures of seizures have been released since then.
In fleeing the country Nirav Modi followed a path shown by businessmen like liquor baron Vijay Mallya who had skipped to London two years ago as a consortium of banks initiated steps to recover more than $1 billion he owed them. He is now facing extradition proceedings there.
Bank accounts are audited at three levels — first by the bank itself, then by its external auditors and finally by the Reserve Bank of India. The failure of the triple audit system to check frauds points to collusion between bankers and businessmen.
The RBI’s immediate response to the PNB fraud, which some have dubbed Niravgate, has been to set up a committee to study the issue of frauds and bad loans dogging the banking sector. It is headed by Yezdi Hirhi Malegam, an octogenarian chartered accountant who was a member of the RBI board for many years. While his credentials are sound, critics point out that his connection with certain rating and auditing firms raises issues of conflict of interest. - Gulf Today, Sharjah, Febriary 27, 2018