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Shame on You Crazy Diamond Bankers

A Swift circular sent back in November 2016 shows the regulator had reason to suspect systemic abuse.
Photographer: Pacific Press/Getty Images

It's disingenuous to think that India's biggest banking fraud was just one bent officer in a bumbling state-run lender enriching an uncle-nephew pair of greedy diamond merchants. That's the spin Punjab National Bank is trying to put on the $1.8 billion scam that went on for seven years.

According to the lender's version, PNB's former employee Gokulnath Shetty provided billionaire jeweler Nirav Modi and his uncle Mehul Choksi with guarantees -- known as letters of undertaking -- so they could get loans from other Indian lenders' branches overseas. These assurances, together with letters of credit meant to give foreign suppliers of pearls comfort about getting paid, totaled 65 billion rupees ($1 billion) between 2011 and early 2017, followed by another 49 billion rupees over March to May last year, when Shetty retired. No collateral was taken from Modi, who has now left the country with PNB still owing the sums to other Indian financial institutions.

Diamonds and Rust

A $1.8 billion fraud by a diamond merchant duo has cratered India's fourth-largest bank by total assets

I have three reasons for doubting this lone-wolf narrative.

First, according to the anatomy of the crime pieced together by Bloomberg News reporters Jeanette Rodrigues and Bhuma Shrivastava, one of the milestones on the road to discovering the fraud was a strongly worded circular in November 2016 from the Reserve Bank of India, cautioning lenders against the misuse of Swift user IDs, of which it said there were too many.

Swift, the global system used to transmit payment instructions, was indeed exploited in the recently unearthed fraud. The messages sent over this WhatsApp-like network led to liabilities accumulating at PNB. That happened as newer (and increasingly larger) funding commitments from PNB were used to repay other banks' overseas branches for their previous advances. Just how the bank's senior management and auditor could have allowed the Ponzi scheme to go on for so long without reconciling Swift messages with internal accounts deserves a separate column.

But the point is, the RBI wouldn't have known about the specific fraud. Sending a circular to all lenders, asking them to verify Swift messages and "explore" their integration with other banks' core-banking software, means the regulator had reason to suspect systemic abuse.

Road to Discovery

These four months played a key role in discovering India's biggest bank fraud

Source: Documents seen by Bloomberg News, PNB complaint to investigators, PNB filings to exchanges

Two, why would the central bank suddenly smell a rat in November 2016? By that time, the $81 million Bangladesh Bank heist by hackers transmitting fake instructions to the Federal Reserve Bank of New York was nine months old. What was very recent at the time, though, was the Indian government's shocking decision to outlaw 86 percent of currency in circulation.

India specializes in importing uncut diamonds and re-exporting them after processing. It's a well known fact the foreign-currency financing that sustains the labor-intensive business offers great scope for money-laundering.

If the industry's requirement for working capital went up manifold following demonetization -- when there was a temporary spike in demand for converting soon-to-be-worthless bank notes into brooches and necklaces using backdated invoices -- then Swift activity may also have seen a jump.

This is speculation on my part. But considering how stretched the RBI was in trying to cope with an angry public anxious to lay its hands on a meager trickle of new currency, the very existence of a November 2016 missive about Swift messaging suggests this wasn't about one rogue banker, or even one state-run bank with weak internal controls.

Finally, the last big Indian scam was the 2009 unraveling of a prominent outsourcing firm. The founder of Satyam Computer Services Ltd. confessed to inflating revenue, and admitted bank deposits claimed in the group's audited balance sheet didn't exist.

After that scandal broke, even highly reputed Indian CEOs were seen handing out bank-account details at earnings conferences to prove their honesty.

This time around, though, the industry at the heart of the scam is getting a pass. State-run lenders are being queried if PNB owes them, when the right question to ask is not about assets, but their own non-fund-based liabilities. How much are they on the hook for? Does the amount include all the promises they've made over Swift? How much collateral are they holding against contingent IOUs?

Nervous shareholders could do with some more transparency. As it stands, this match-made-in-hell story of one crooked client having found one dishonest banker won't wash.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Andy Mukherjee in Hong Kong at amukherjee@bloomberg.net

    To contact the editor responsible for this story:
    Katrina Nicholas at knicholas2@bloomberg.net

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