The government’s dilemma with PNB

Punjab National Bank

Madhuchanda DeyMoneycontrol Research

Even as the bad loan mess is playing out, the banking sector has been jolted by a massive fraud. On Wednesday, Punjab National Bank informed stock exchanges about some fraudulent transactions at one of its branches in Mumbai, amounting to $1.77 billion (around Rs 11,300 crore).

While the details are still awaited, a host of Indian banks through their foreign branches had extended credit to the beneficiary on the basis of LOU (letter of undertaking) issued by PNB.

An LOU is in effect a letter of comfort issued by one bank to branches of other banks, based on which foreign branches offer credit to exporters. Foreign branches of these banks, which had relationships with Gitanjali Gems and Nirav Modi Group firms, had taken significant exposures.

Who will bear the brunt?

While the initial understanding was that PNB would be liable to honour these claims, as the trail of the fraud unfolds, it is gradually coming to light that the fraud was committed with the connivance of multiple entities including some officials at the foreign branches of Indian banks.

Six banks reportedly have discounted bills against PNB-issued LoUs to the errant borrower. Union Bank, Axis Bank, SBI overseas branches, Bank of India, Canara Bank and Allahabad Bank extended buyers credit against PNB's LoUs. Axis Bank reportedly has sold down its exposure.

While the money was sent to PNB Nostro A/c (foreign currency account of the Indian bank) and hence PNB prima facie stands liable, the jury is out on the nexus between the errant borrower and overseas branches of other Indian banks.

What happens to PNB?

 Punjab National Bank had a rough ride in the NPA cycle. The bank has reported gross NPA of 12.11% (Rs 57,519 crore) and net NPA of 7.55% (Rs 34,076 rore). PNB’s total stress loans stands at close to 15% comprising 12.1% gross NPL, 2.1% standard restructured loans and the rest through other formats. Hence post the recent RBI circular, the gross NPA would stand increased to 15%.

If we assume PNB has to create additional provision of Rs 4000 crore out of the new RBI circular and an additional liability of Rs 11,300 crore for the fraud, where does it leave the bank?

PNB has a reported net worth of Rs 34,000 crore. The bank has recently raised Rs 5000 crore by way of Qualified Institutional Placement (QIP) at a price of Rs 168 per share (current price of Rs 130) and is also expecting Rs 5473 crore by way of recapitalization from the government.

If PNB were to pay up for the fraud, it will basically bring it back to square one. In fact, worse off compared to its pre-recapitalisation state.

It remains to be seen how the fire is doused – by forcing PNB to pay up and  thereby sparing the rest of the financial system from contagion, or by adopting the path of endless litigation. With the doors of further capital raising from the market looking unsure for PNB, government will have to find a route to restore the health of the second largest PSU bank.