COMMENT-The PNB scam: Questions for the bank, the auditors, the RBI and the government

Though the depositors have nothing to worry about, PNB’s blunders raise many questions to all stakeholders. There is no point asking these questions to Nirav Modi and Mehul Choksi of Gitanjali Gems unless one wants to learn the art of swindling a bank. We shall restrict our questions to the key stakeholders –PNB itself, auditors, RBI and government of India.

Question to PNB management:

When will you learn from your scams?

Either the senior management of the bank was incapable of knowing what was happening in the bank or it deliberately did not want to change with time. Private sector banks have moved with the times and have systems in place where all business units are technologically integrated. This is the case with State Bank of India, the largest public sector bank, and many smaller banks. Yet the second-largest bank did not feel it necessary to upgrade its system and integrate the Society for Worldwide Inter-Bank Financial Telecommunication (SWIFT) with its core banking system.

Also Read: CBI arrests PNB's GM-rank officer in fraud case

PNB is an excellent example of how it survives only because of government’s backing and unaccountable use of taxpayers’ money. Way back in 1990, PNB’s London branches saw a similar scam resulting in the branches being merged with SBI. The bank’s chairman at that time lost his job though he was not involved in the scam.

In the recent past, too, PNB has been hit by similar scams using a similar modus operandi, when Winsome Diamonds & Jewellery Ltd, Forever Precious Jewellery & Diamonds Ltd and Zoom Developers Ltd were caught. In fact, PNB has the unenviable distinction of having the highest number of wilful defaulters as well as the largest amount outstanding from these accounts as per the CIBIL website.

Yet the bank refuses to learn.

It may, however, be pointed here that the only reason that we know of this scam today is that a PNB employee exposed the racket. It is very unfortunate that such employees who are willing to stand up against corruption are few.

A Letter of Undertaking (LoU) or Letter of Credit (LCs) is normally offered to clients where the bank has a longstanding relationship with the client and there is enough margin of safety with the bank. PNB kept  rolling a Rs 280 crore account to Rs 11,300 crore over a period of seven years. A CBI official has been quoted as saying that there were 150 such LoUs during the seven-year period.

PNB management not knowing that a small group of people was evergreening an account to the extent of Rs 11,300 crore, and having money disbursed from their Nostro account, speaks volumes about their lack of internal systems and their control over the bank. Incidentally, the Rs 11,300 crore that has been swindled away is nearly one-third the net-worth of the bank.

Question to the auditors:

When will the watchdog wake up?

Given the number of financial scams world over it is high time auditors change their role from being a watchdog to a bloodhound. Unfortunately, auditors have been found wanting. There are few cases where the auditors have shown their might, like the current one in Fortis Healthcare where the auditor pulled up the management and refused to sign the accounts.

If there was a breakdown of checks and balances in PNB, the auditor should have been the first to point it out. Reshmi Khurana, managing director, Kroll India has been quoted as saying “Such frauds can only be captured if auditors, whether internal or statutory auditors, monitor high-value or unusual transactions on a routine basis.”

Various experts from the auditing community have been quoted in media pointing out the shortfall by auditors. Amarjit Chopra, former president of Institute of Chartered Accountants of India said “The technology auditors of the bank need to be asked how come two technical systems, SWIFT, and the core banking system, do not talk to each other. It is a case of system failure.”

Auditing is beyond balancing the Profit & Loss account and the Balance Sheet. Auditors need to have a thorough understanding of the businesses they are auditing and the loopholes that are exploited by management.

Question to the RBI:

When will you practice what you preach?

If various layers meant to check fraud have failed then calling it as a systemic failure will not be wrong. Multiple layers of checks and balances within PNB failed to detect the scam and if not for the employee who raised the red flag, the issue would have never come up. The regulator, RBI, which is mandated to ensure the safety of the banking sector, was unaware of the fraud. That is an Rs 11,300 crore oversight from the central banker.

The government of India is also questioning RBI’s role, especially since one of the deputy governors had mentioned that similar scams were taking place in the banking system.

In a speech delivered on 7 September 2016, former RBI deputy governor S.S. Mundra said, “We have also come across instances of fraudulent messages confirming documentary credits being transmitted using SWIFT infrastructure. Although the latter incidents were mainly a result of the failure of internal controls and non-adherence to ‘four eyes principles’, it is also on account of reliance on disparate systems whereby SWIFT transactions could be done without originating a corresponding transaction in the CBS.”

Some PNB employees were doing just this.

When RBI knew how such scams could take place, why did it not stop this particular one, and run a fine-toothed comb through the entire banking system?

RBI has been advising banks to be vigilant and transparent, yet it was found sleeping on its watch.

Question to the government:

When will you stop wasting taxpayers’ money?

With nearly Rs 10 lakh crore in non-performing assets and a regular dose of bailouts needed every 10 years, public sector banks are money-guzzlers. Banks have over the years used government and taxpayers’ money as their ATMs. Yet there has been no accountability.

A recent message that was floating around quoted what various bank chairmen have been saying about the NPA issue. The common message for nearly a decade is that the worst is behind us, only for us to be confronted by a new set of problems. Either the bank chairmen are not aware of the rot in their system, or are just biding their time and hoping that the bomb does not blow up in their hands and they can sail safely into retirement.

Industry body Assocham has asked the government to privatize these banks. They are not far from the solution. Bank unions have naturally criticized Assocham’s move. These unions are the same ones who criticized the computerisation of the banking system; nothing constructive can be expected from them.

Privatising the banks will make the management accountable to the shareholders and free them from government interference. It is not without reason that private sector banks have lower toxic assets. Thanks to the NPA issues government has committed pumping in Rs 2.3 lakh crore into the banking system. This should be sufficient until the next time banks face similar problems and approach the government for taxpayer money.

As the promoter of public sector banks, government cannot wash its hands of the problems the sector is facing. Clearly, it is not able to manage. Better to privatise and utilize taxpayer money prudently rather than feeding the Nirav Modis and Mehul Choksis of the world.