International Forecaster Weekly

India’s Biggest-Ever Bank Fraud Unravels

... let me tell you how delighted I am at your intimate knowledge of internal banking regulatory systems and the SWIFT protocol in general. And you're exactly right. This is where the story gets interesting.

James Corbett | March 3, 2018

It has all the elements of a Hollywood heist movie: A well-known jeweler-to-the-stars and his shady accomplice. A risky gambit to exploit a banking loophole. Inside help from a high-ranking official. A $2 billion swindle. And the whole house of cards crashing down in spectacular, front-page fashion.

But here's the Bollywood twist: The well-known jeweler is Nirav Modi. The high-ranking official is Gokulnath Shetty, deputy manager of the Punjab National Bank. And the amount pilfered is 11,700 crore rupees.

For those not in the know, Nirav Modi is known as the bold upstart who bought up a slew of top-shelf diamonds in the depths of the 2008 economic crisis and made a fortune designing and selling his own line of "haute diamantaire" for the Hollywood glitterati. Read any rundown of the red carpet in recent years and you're likely to read descriptions of Ms. So-and-so wearing a "dazzling Nirav Modi statement necklace" or some such twaddle.

But Modi's zero-to-hero, "Mumbai boy makes it big" story came to a crashing halt last month when India's Central Bureau of Investigation unveiled a complaint from Punjab National Bank alleging a multi-billion dollar swindle allegedly run by Modi and his business partner, Mehul Choksi. Soon, Indian authorities were sealing off Modi's expensive properties, seizing his diamond inventories, and beginning a game of "Where In The World Is Nirav Modi?" that took several eyebrow-raising twists and turns, including the tidbit that his last known public appearance was at the World Economic Forum in Davos.

So what was the swindle, exactly? It all revolves around a financial instrument called a "Letter of Undertaking," or "LoU" for short. An LoU is issued by an Indian bank to a foreign bank on behalf of one of its customers. It guarantees the credit-worthiness of the customer and puts the issuing bank on the line should the customer default.

As you can imagine, LoUs are not issued willy-nilly. They depend on the issuing bank's pre-existing credit relationship with its customer, and naturally there is the assumption that the issuer has done its due diligence on the customer and secured some collateral for the credit that the foreign bank is extending. Strangely, that seems not to have happened in Modi's case.

According to the information that is being dribbled out to the public about the Modi case, the bank that issued the LoU, the Punjab National Bank (PNB), did not have any record of having issued these LoUs. And yes, that's LoUs plural because the instruments are only good for one year and the scam has been going on since 2011. That means that, somehow or other, the PNB issued nearly $2 billion worth of LoUs on behalf of Modi and his partner on multiple occasions without knowing it. Actually, let me rephrase that: "without 'knowing' it" (nudge, nudge, wink, wink).

"But surely that's impossible!" you contend. "The LoUs are issued through SWIFT, the international banking network that the US uses as its own personal battering ram in the geopolitical sphere (even though it's 'totally not political'). And we all know that SWIFT transactions require three separate inputs from three separate banking officers, the initiator of the transaction as well as a checker and a verifier. And even when the transaction is sent, the recipient bank sends a confirmation back to the sender, which is often processed by another party altogether. There's no way a bank could issue LoUs via SWIFT without multiple people knowing!"

Well, dear reader, let me tell you how delighted I am at your intimate knowledge of internal banking regulatory systems and the SWIFT protocol in general. And you're exactly right. This is where the story gets interesting.

We know that Modi and Choksi had inside help on the scam. The above-mentioned deputy manager of the PNB, Gokulnath Shetty, has admitted to giving Modi's aides his "level 5" password that is used to issue LoUs on the SWIFT network. But that still doesn't explain how the LoUs were approved or verified, or who was handling the confirmations that the foreign banks were sending back when they were issued.

But don't worry too much about that. We have a different problem to worry about, according to India's banking regulators: the PNB's outdated computer systems! You see, it seems the bank's central system was not tied in to the SWIFT software itself. Instead, all SWIFT transactions had to be manually entered and reconciled, meaning that if an inside official "overlooked" this step, then SWIFT transactions could escape the bank's records entirely.

Long story short: Modi and his partner had inside help in securing nearly $2 billion in loans from foreign banks that were never repayed, and the PNB is left holding the bag.

To put the scope of this problem in perspective, the 11,700 crore rupees allegedly netted in this scheme is equivalent to 1/3 of PNB's entire market cap. Or should I say was equivalent to 1/3 of its market cap. Shares in the bank plunged when the news was released and the bank's market value dropped almost 11,000 crore rupees in a matter of days. Oh, and since it's a state-owned corporation, guess who's ultimately left holding the bag to keep the whole thing afloat? Oops, sorry about that Mr. and Mrs. Taxpayer. We promise that won't happen again!

So how did this really happen? Diamond entrepreneurs don't generally come out of nowhere, become celebrity designers, get hailed on the red carpet, and pull off multi-billion dollar bank heists without something else behind them. Hmmm...

Oh, right. I guess it helps to exchange the right handshakes with the right royals and all that. Just ask Jimmy Savile.

But the worst part of the story is that it's quite possible we haven't seen the worst part of the story yet. Given that the PNBs outdated computer systems are a key part of the scandal, it's entirely possible that this scam will be used by Prime Minister Modi (no relation) to continue pushing his "black money" / de-cashing / Aadhar agenda to make India a "world leader in electronic payment processing" blah blah blah.

Yes, that's right, the world's largest biometric database has been steadily rolling ahead for the last several years and despite several suppressed reports about how the database has already been compromised it is now mandatory for every single Indian citizen to link their bank account to their government-issued biometrically-"secured" Aadhar number. (Remember, folks, you only have until March 31st to do it or you'll get de-banked!) And now we have a front-page scandal (in the Indian press, that is) where a central conceit is that a bank's outdated computer systems are to blame for the biggest case of bank fraud in the nation's history.

Don't worry, guys, it'll all go away when every bank employee and every customer has to give their iris scans, fingerprints, DNA and fingernail clippings for every transaction! Honest!

However this turns out, it will be interesting to see what nuggets of info spill out during the investigation and prosecution of this case. I'll make the bold prediction right now: Modi, it turns out, was an innocent victim of this whole scam. He just enjoyed the occasional pizza party with Prince Charles, who personally vouches for his upstanding nature, and all charges will be dropped on the spot. But let's hope I'm wrong.

Happy banking, everybody!