Eternal vigil and quick punishment, not privatisation, is the answer to bank fraud.

 Mythili Bhusnurmath

Senior consultant, National Council of Applied Economic Research

For the past fortnight or so, the Rs 11,400-crore fraud at the Punjab National Bank (PNB) has been hogging headlines; without any let-up. Even as clarity on the exact quantum and the modus operandi eludes us – is the amount Rs 280 crore as reported by PNB in its first information report or Rs 22,000 crore as reported in some papers; did the alleged perpetrator of the fraud, Golkulnath Shetty, act alone or were others in the loop, and on the take as well; how come these huge transactions escaped the notice of PNB’s auditors and Reserve Bank of India (RBI) inspectors, and so on – there’s been an outpouring of anger, bordering on hysteria.

Especially now that political parties have joined the blame game!Opinion on what ails public sector banks (PSBs) and ready solutions have been quick in coming, with most commentators portraying fraud as unique to PSBs and, as a corollary, calling for their privatisation.    


 The latest to join the bandwagon is none other than the Federation of  Indian Chambers of Commerce and Industry (FICCI): “FICCI firmly believes that the recapitalisation of public sector banks alone is not a permanent solution and will not be effective unless the inherent issues related to governance, productivity, risk management, talent, customer service, etc. are resolved.


Given the continuous pressure on the government finances on account of the weak performance of the banks, the government should consider privatisation of Public Sector Banks,” says the statement issued by the industry body. Really? Is the answer so simple? Are private sector banks immune to fraud? Is privatisation the answer? The answer to all three questions is a resounding ‘No’! As experience, both in India and overseas, shows, frauds are not unique to PSBs. Nor for that matter are the NPAs (non-performing assets). In the context of the Nirav Modi case at the PNB, both fraud and the NPA have often been used inter-changeably.

But there is an important, if subtle, difference.A non-performing asset (NPA) is an asset, typically a loan in the case of a bank, where either the principal or interest or both, is not paid on the due date. This could be due to a host of factors, including, but not limited to, fraud.

Thus, faulty credit appraisal at the time of loan sanction, poor business decisions, poor post-sanction follow-up or extraneous factors (such cancellation of coal block/spectrum allocations in the power and telecom sectors in India), global slowdown following the Lehman Bros collapse etc, could result in NPAs. 

In contrast, fraud is a deliberate act done with the intention to cheat and if not caught and addressed in time, could make the asset non-performing. In the instant case, without doubt, bank officials at PNB colluded with the borrower to issue letters of undertaking (LoUs) that they were not authorised to issue. Their fraudulent act enabled Modi to indulge in what is known in banking parlance as circular trading, ie pay for imports with the proceeds of loans extended against fresh LoUs. The fraud was detected only when the chief perpetrator retired and the official who replaced him refused to issue new LoUs without adequate margin. And, on being told this was the regular practice, he tried to scrutinise past records; only to find there weren’t any! That’s when the skeletons came stumbling out! Since it appears Modi does not intend to pay his full dues, the loan is now an NPA.

So here is a case of fraud resulting in an NPA which raises two questions. Was there a failure of systems at the PNB? Most certainly, yes! All the safeguards normally used in the contest of SWIFT, the coded messaging system meant to ensure veracity of the message were given the go-bye.

Without doubt, therefore, this must be fixed and the guilty must be punished. But can we extrapolate this admittedly spectacular and inexplicable failure to say all PSBs suffer from faulty systems and are prone to frauds? Not at all! The 1992 Harshad Mehta fraud, that held a pride of place in the annals of banking fraud in India before being overtaken by Nirav Modi, involved two banks: State Bank of India, a public sector bank and ANZ Grindlays, a foreign bank. More recently, the multi-billion dollar fraud involving manipulation of  LIBOR (London Inter-bank Offer Rate), the base rate for inter-bank transactions, involved some of the most “respectable” names in banking – Barclays, Royal Bank of Scotland, JP Morgan, Deutsche Bank, HSBC, Citi – every one of which is a private bank.  

  As for the NPAs, the largest bank-bailout in recent times was the $800 billion Troubled Assets Rescue Programme (TARP) extended under George Bush to bail out US banks and insurance companies in the aftermath of the Lehman Bros collapse. Again, none of these was publicly-owned. In the UK, following the virtual collapse of the Royal Bank of Scotland in 2008, the government nationalised the bank. Ireland did likewise with its banks when they ran into trouble.

Nationalisation was seen as the answer to troubles in the banking arena! Closer home, both Global Trust Bank and Bank of Rajasthan were private banks – the former under once high-flying Ramesh Gelli – that had to be rescued by public sector banks. 

The harsh truth is that banking is not like other businesses, where the fallout from the failure of a single business can be contained. Inter-linkages between banks and the fact that they are the backbone of the payments’ system in a modern economy means the failure of even a single bank – if it is large enough- can bring down the entire edifice of modern finance.

Consequently, regardless of whether a bank is privately or publicly owned, no government can afford to let it sink. The US Government opted to test that hypothesis by allowing Lehman Bros to go under and all of us have experienced the fallout of that – a decade of economic disarray and slowing growth.      


 The question, therefore, is not whether a bank is privately or publicly-owned but how it is run. The only way to tackle fraud is through constant vigil, by banks, by auditors and by regulators. In the Nirav Modi case, clearly all three failed.