Understanding The Punjab National Bank Scam

By | February 22, 2018

The Punjab National Bank fraud, which came to light on February 14, has rattled an already troubled Indian public sector banking community. Here’s what happened.

Understanding The Punjab National Bank Scam

The Punjab National Bank fraud, which came to light on February 14, has rattled an already troubled Indian public sector banking community. The alleged fraud of Rs. 11,400 crores ($1.77 billion) by multi-billionaire diamond design jeweller Nirav Modi and his associates at a single Mumbai-based branch is already being hailed as the biggest banking scam in Indian.

While the magnitude of the fraud is in the limelight, the various lapses within the internal control system of the Punjab National Bank have also come to the fore. Questions are also being raised about the internal working of other public sector banks.

This is of greater significance now due to public sector banks (PSU) already being in the limelight for their non-performing assets (NPAs). The Government and RBI are looking to ease the pressure of NPAs on PSUs through a recapitalisation plan of about Rs. 2.11 trillion.

However, the PNB fraud threatens to wipe out the recapitalisation benefit that was due to the bank.

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Let’s try and understand the nature of the fraud and the manner in which it was carried out. Many are calling it a classic fraud right out of the banking fraud textbooks.

Terms and Terminology

It’s useful to know these terms before understanding the nature of the fraud:

Buyer’s Credit

Buyer’s credit is a type of loan extended by overseas banks and financial institutes to importers. This loan helps importers fund the purchase of big-ticket items. Buyer’s credit is generally meant for big export orders and starts with million dollars to begin with. This loan is usually extended for a short term and at a low rate of interest.

Since the loan amount is big, overseas banks and financial institutions sanction it against a Letter of Undertaking (LoU). A LoU, also known as a bank guarantee, is a document issued by the bank of the importer to the lender bank overseas.

This loan product is an effective tool to conduct international trade as most exporters can rarely afford to give big credit to importers.

Letter of Undertaking

An undertaking or promise given by the buyer’s bank to the seller stating that if the latter presents pre-specified documents to the buyer’s bank regarding a transaction as per a purchase agreement, the buyer’s bank will make a payment to the seller.

Since large amounts of money is part of the dealing, banks extend a LoU only when the borrower provides collateral or security of some kind, or a cash margin.

Banks send these LoUs to foreign banks through Society for Worldwide Interbank Financial Telecommunication (SWIFT).

What is SWIFT?

This is a network between banks worldwide to facilitate payments or share information about financial transactions.

What happened in the PNB Nirav Modi case?

It is alleged that two employees from the PNB Mumbai branch in question issued LoUs in favour of Nirav Modi in a fraudulent manner. These LoUs were given without collecting any collateral or security. So when the three firms of Nirav Modi, which were extended credit, defaulted on payment, the liability to pay the dues fell on PNB. Since PNB did not have securities or guarantees from Nirav Modi, the loan became a liability in the bank books.

According to news reports, the bank officials not only extended LoUs in a wrongful manner, they also bypassed the bank’s internal record system to send the LoUs via SWIFT to bank branches in Hong Kong. Due to this, the transactions did not get recorded in PNB’s core-banking system (CBS).

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What Have We Learnt?

Legal proceedings regarding the matter have started and it’ll be a while before we get a complete picture of the PNB fraud case. But don’t let one wrong case dissuade you from pursuing a career in trade, be it big or small.

If you are looking to enter the trade business then the following brief on trade finance will come in handy.

What is Trade Finance?

Trade finance or trading loan is a form of financing that is provided for the purpose of conducting domestic and/or international trade. Banks and financial institutions can be the providers of such financing. This kind of financing gives an extra level of protection to the buyer and quicker access to funds to the seller.

Products offered under Trade Finance

A trade finance or trading loan availed from most banks will normally have one or all of the following products and/or services –

Letter of credit

An undertaking or promise given by the buyer’s bank to the seller stating that if the latter presents pre-specified documents to the buyer’s bank regarding a transaction as per a purchase agreement, the buyer’s bank will make a payment to the seller

Bank guarantee

An undertaking or promise wherein a bank stands guarantee on behalf of an applicant in favour of a beneficiary. If in case the applicant fails to deliver to the beneficiary on pre-specified terms or agreement, the guarantor bank will make a payment to the beneficiary upon receiving a demand or a claim. The different types of bank guarantee can be mentioned as follows –

  • Tender Bond
  • Advance Payment
  • Performance Bond
  • Financial
  • Retention
  • Labour

Bill Collection and Discounting

Herein, the seller’s bank collects the payment from the buyer or buyer’s bank for the goods or services purchased

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Details for Trade Finance (Trade Loan) Options in India

Globally, eligibility criteria for availing trade finance remains more or less the same. Based upon specific banks, additional criteria might come into play. But, on an average, the following conditions, if met, qualify a customer to avail a trade loan without any hassle –

Age: As with any kind of loan, the interested customer must be of legal voting age or above and allowed to conduct business, either in partnership or proprietorship

Business Age: The minimum years required for a business to be functional varies from bank to bank, but could be anywhere between 2 years to 4 years

Loan Limits: These again vary with banks. Lower limits start from Rs. 15,000 to Rs. 30,000. The upper limits could be decided as per the need of the customer and the limits set by the bank.

Loan Tenure: Tenures for repayment of the loan can be as high as 60 months and can be as low as decided by the customer or permissible by the bank

Loan Security: Most banks will allow securities in the form of mortgaged land (excepting agricultural land), National Savings Certificates, government bonds or Fixed Deposits. Some banks might also accept Life Insurance policies in the name of the borrower, partner, proprietor or director as security

Margin on Loans: Based on the security provided, the margin allowed by different banks could vary between 5% and 45% of the security provided.

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 Documentation required for availing a Trade Loan

 Being a Secured Loan, there are specific documents that need to be furnished to avail a trade finance scheme without any hassle. The most common documents required are as follows:

  • Balance sheet/profit-loss statement for the past 2 to 3 financial years
  • Declaration of annual sales along with tax returns
  • Assessment of sales tax/income tax
  • Stock statements
  • Proof of insurance of premises and/or stock
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Loans are a great way to meet short-term financial needs or to purchase big ticket items that can otherwise cause a dent in your savings and investments. Whether it’s a Home Loan, Car Loan or a Personal Loan, we have a host of them on offer. We also have amazing deals on Credit Cards and some amazing investment options. Click the link to check out our website.

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