Punjab National Bank scam: Experts discuss key developments

The Rs 11,000 crore fraud at Punjab National Bank (PNB) is taking several twists and turns, and it is a story that has multiple threads like political, regulatory, commercial and even investigative.

In an interview to CNBC-TV18, three Former RBI Deputy Governors, KC Chakrabarty, R Gandhi, and SS Mundra, and RK Bakshi, Former ED of Bank of Baroda discussed about the various developments in the PNB fraud.

Below is the verbatim transcript of the interview.

Q: Let me start by asking you and this was a question that was asked at the PNB management as well, in their press conference today, where does the liability lie. The response from the PNB management was that it will at the end of investigation process and perhaps on the direction of the Reserve Bank of India (RBI) if we do have the onus of repayment, then we will take on the responsibility, we will honor our bonafide commitments. Now the six banks that have been in some form or fashion been involved in these transactions, argue that the liability must be borne by PNB as the money was sent to the banks nostro account. How do you react to that?

Mundra: Let us begin like this, number one, the information which has come is too sketchy still to really know the full facts of the case. However, having said that, on the face value, without quoting this particular instance, I would like to say that if the instruction has gone through the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system, which is a secured, recognized, authentic, communication system, from one bank system if money has come into the nostro account of that bank when the Letter of Undertaking (LoU) discounting banks have disbursed and then that money has been utilized, and some argument that this was done by some employees fraudulently, but I think then there is the question of agent principle relationship and I do not think on that ground a principle can refuse the transaction.

So, if these are the three prerequisites which have been made, then obviously on the basis of, if these are all confirming evidences are there, then it is very clear liability would be on the part LoU issuing bank. However, if there are other factors and the matter enters into any kind of dispute, then ultimately it will be the investigation and judicial authority. I do not think it would be possible for RBI or regulator to if matter has entered into a judicial dispute then any kind of directions like that, summary directions can be given, I don’t think so.

Q: KC Chakrabarty, would you agree with SS Mundra that it would not be possible for the RBI to give any sort of summary directions in this matter given the fact that this matter is now under investigation, this was the point that the PNB management also made today that they have received no direction from the RBI on addressing this issue of liability.

Chakrabarty: If some bank complaints that we had given the money out of the Letter of credit (LoC) and that bank is not acknowledging that or not respecting that particular thing, then if RBI examines and they find that everything is okay, no problem, but if there is a legal dispute, there is an issue. In LoC business always this problem happens that any small change anywhere makes the LoC default.

Generally whenever this problem happens, ultimately it has to be resolved legally depending facts of the case. However, if it is brought to the notice of the RBI that these are the facts of the case, then sometimes RBI may ask the bank because ultimately LoC of a bank has to be honored, it is the issue of international practice of banking. So that is the basic issue, but generally this all goes to legal disputes in such big cases when the fraud happens.

Q: Since we are talking about facts, PNB in its cautionary advisory that it issued to 30 banks yesterday, said that Indian Banks did not adhere to the RBIs guidelines on the 90 day LoU window for exports while extending the credit and hence I guess they are also putting a question mark then on why the liability should end at their door.

Bakshi: This is a point that has been made by PNB, but I will think that banks aboard, are they supposed to be bound by the LoU that has been given to them or supposed to be in the knowledge of RBI regulation. Suppose it was a foreign bank discounted, and it is possible that in a particular case PNB might have issued the LoU after obtaining forbearance from RBI. It would have been an alertness on the part of the foreign discounting branch to point it out, but whether it can put a blame on them or liability on them that they overlooked this fact, they are liable, that to me does not appear. However, everything will depend on the facts of the case.

If it was a regulatory violation, violation is first on behalf of PNB which has issued it for 360 days, not on behalf of the discounting banks which has discounted such a LoC. If at all it is found by the regulator that they were also in error, then a regulatory action can be taken against them. However, PNB cannot, on this basis to my mind, prima facie without knowing all facts of the case, cannot renege on their liability.

Q: From a perspective of a lay person who is watching this program and we heard what the PNB management had to say, the two junior branch level officials were the main perpetrators behind this alleged Rs 11,000 crore fraud. It went through the SWIFT system, it did not go through Core Banking, I mean for seven years this has gone on. It started in 2011, in February of 2017, there have been eight transactions almost amounting to Rs 280 crore. So this has gone on for the last seven years and it is not as if the pace of the transactions have decelerated. How do you explain this to a lay person, how can something like this be pulled off and what about the role of the RBI?

Mundra: That is why I said in the beginning that the details which are available are too sketchy to really reach to a firm conclusion. I really do not believe that from 2011 if there was a spate of continuous fake LoUs which were being discounted and being paid, if outstanding we are talking of Rs 11,000 crore which is at this point of time and we say it has been happening for six to seven years, then you are talking a turnover which can well be Rs 50,000-60,000 crore. So, information available is inadequate.

As far as the question I mentioned in the beginning, question of junior employees and all that, it is a principle and their agent issue, so, that cannot be a ground for disowning any kind of responsibility. However, the key question is there has been an operational failure, it is the failure of system and the risk management. In fact personally I remember sometime in September 2016 I had delivered a speech and I had exactly mentioned about this kind of possibility and in June 2016 RBI had come out with a comprehensive checklist.

Q: What gave you reason in 2016 to raise the red flag on this issue. Did you have evidence to suggest or did you have reason enough to be concerned that you actually made reference to this in June of 2016. Not this specific case but this operational failure that you are talking about?

Mundra: There has been instances where there have been effort to manipulate the SWIFT system. There have been one case about the Nostro (Nostro account refers to an account that a bank holds in a foreign currency in another bank) trail; Nostro which was filed, I won’t go into the detail but there were attempts. So I think while we are discussing what is happening today but to my mind, and I would like to use this opportunity, basically we should look forward and three things are necessary. One, there should be a seamless integration interface between the core banking solution (CBS) system and SWIFT system without any manual intervention in between and that’s very important. The second point, is this kind of activity should not be dispersed at hundreds of branches. Each bank should create few centralized center and this is what we had suggested, we had mentioned. Ultimately RBI or any regulator would not be in the business of running day-to-day activities. The banks would be given certain warning signals but this for them to implement. So that centralization of this activity is also very important but the third point I would like to mention at this point of time – with this kind of instances emerging, I think it is now appropriate to do a national level check and for that let us pick up a cutoff date of January end and all the Indian banks who have discounted against the LoU, let them reconcile with each other. Maybe we will not be able to cover some of the foreign banks but these LoUs are typically discounted with Indian banks maybe overseas branches. This one type of reconciliation to my mind now looks very important, so that we can be sure that this kind of risk in a large proportion is not fitting in the system – that is something I think will be very meaningful if we can convey the message very loud and clear.

Q: Would you like to add to what we now need to focus on to ensure that we do not end up in the situation a few months down the line or a few weeks down the line?

Bakshi: I would like to add but while endorsing whatever Mr. Mundra has said, he is a very senior banker and very valid point made by him. I would like to add one thing which was to my mind the biggest gap if that risk mitigation would have been practiced the fraud would have been nipped in the bud on the very first day, which is it should be the standalone system the log of the SWIFT, days messages must be independently gone through by some officer at the end of the day because ultimately you are leaving a key to the treasure in the hands of two people. If the messages are verified at the end of the day, immediately unauthorized messages would have been noticed. When we used to have earlier the telex system, the telex roll the carbon copy was at the end of the day verified individually and all messages were ticked whether only authorized messages have gone.

In this case how can you leave a standalone system which can create liability of billions of dollars and the messages are not checked neither by concurrent auditor nor by some officer. They should be checked every day.