PNB Scam – How it Happened through Letters of Undertaking (LOU) ?

11,500 Crore PNB Scams has hit the nation.Read – PNB Detected Rs 1.13 Lakh Crore Fraudulent Transactions ,How did this huge scam happened by single entity  and regulator were not able to trace it for so long ? This scam is not just limited to Punjab National Bank rather other banks like Allahabad Bank, Axis Bank, Union Bank of India are found in fix as they had offered credit based on letters of undertaking (LOUs) issued by PNB.

What is this letters of undertaking (LOUs) ?

First of all, let’s know about the Letter of Undertaking (LOUs), which is the major reason for such a huge scam. Letter of Undertaking is a type of bank guarantee and is issued for overseas import payments generally applicable for Forex branches of Indian Bank’s.

A bank, while issuing LoUs for their customer, agrees to repay the principal and interest on the customer’s loan unconditionally. The main parties involved in issuance of Letter of Undertaking are an issuing bank, a receiving bank, an importer and a beneficiary entity overseas.

Mode of PNB Scam

In this case of PNB Scam the Mode of operation was simple as like any LOU issued on demand of importers. Geetanjali Gems and related firm of Nirav Modi requested for issuance of Letter of Undertaking from PNB,. hence agrees to repay the principal and interest on their overseas loan unconditionally. Based on this PNB issued LOU, Nirav Modi firm raised loan from overseas branches of Indian Bank like Union bank of India, Axis Bank, Allahabad bank etc. Once the loan account get matured, PNB settle the loan account. 

Here the involvement of PNB staff, while delivering the Forex credit, payee bank usually ask for confirmation through SWIFT messaging system which is used for overseas transaction and verification of guarantees given on LoUs. PNB branch personnel verified the SWIFT message from overseas branches of lending bank without taking necessary sanctions. As a result, overseas branches of many Indian banks gave Forex credit.

The jewellery company, which has shops in foreign locations such as Hong Kong, Dubai, and New York, had been availing buyers’ credit based on such LOUs from as early as 2010.Problem started when PNB officials had sought additional margin of around 10% on the jeweller’s exposure for the facilities to continue. As the jeweller was unable to provide this, the facilities were withdrawn, leading to a collapse. 

As PNB refused to honour the LOUs, one of these banks had reported the matter to the Hong Kong monetary authority, which is the local regulator, and also the Reserve Bank of India. Bank’s who processed the buyer’s credit said that their exposure was against the PNB bank, not on the client, Nirav Modi. Based on the LOU, they have remitted the amount.

Nirav Modi companies were maintaining only current account with the branch and were not enjoying any fund or non-fund based limits. None of the transactions were routed through the CBS [core banking solution] system, thus avoiding early detection of the fraudulent activity. Buyer’s credit were issued for one year where as RBI stipulates 90 days from the date of shipment. Overseas branches of Many Bank’s overlooked this important parameters while collecting confirmation through SWIFT.