It has been several years since I used the phrase “shameless audacity”, but somehow I feel compelled to use it again and again to describe the saga of this newer Modi: and here everything is personal. The reason is: in a country of 1.2 billion people the majority struggles to have access to basic amenities to survive the day-to-chaos and challenges, and then we meet and see these characters, rather filthy ones, who were born on the back seat of Audi and could simply rip us off (in this case one of the biggest nationalised banks in India with over 80 million customers, 6,937 branches, and 10681 ATMs across 764 cities). It is personal because at present (and most likely in future as well) we don’t know who will pay the price. Mallya lives abroad, Lalit is out there, and now Nirav and Mehul. Who says earning money is bad, work hard or be smart and earn; don’t just rob us. Then it becomes personal. It is personal because people like me have to roam around bank branches just to understand the technicalities, and you guys suddenly find a way out (of the country with the money of all of us).
During my college days back in Tata Institute of Social Sciences, Mumbai we had several discussions about “Banker to the poor” and how banks should reach out to people: Banking and Microfinance being one of the subjects; it is around that time when investment banking took a fall and Lehman Brothers could not sustain any longer. Slowly we got into jobs and higher studies and those discussions became limited to our occasional conversations, and now they take space on social media. For this article, I am using various message and posts written by different Indians and non-Indians (including media houses). I don’t wish to have any copyright for any material presented in this article.
Who is Nirav Modi:
- Indian-born diamond jewelry designer Nirav Modi is the founder of the $2.3 billion (revenues) Firestar Diamond.
- Modi grew up in Belgium, dropped out of Wharton and moved to India where he got trained in the diamond trade under his uncle.
- He went on to launch his own Nirav Modi brand with 16 stores in locations such as Delhi, Mumbai, New York, Hong Kong, London and Macau.
- In 1999, Nirav Modi set up a diamond sourcing and trading company called Firestar Diamond. The company is worth $2.3 billion today.
- Brand Nirav Modi debuted with a pair of earrings that the billionaire designed for his friend in 2008.
- Nirav Modi has a long list of star clients – Kate Winslet, Steven Spielberg, Sharon Stone and Aishwarya Rai to name a few.
- Donald Trump, now US President, inaugurated his first store in New York’s Madison Avenue in 2015.
- Last year, Priyanka Chopra, who scored Hollywood success with her hit series Quantico, was roped in as the brand’s global ambassador.
- Nirav Modi has jewelry boutiques across three continents – in London, New York, Las Vegas, Hawai, Singapore, Beijing and Macau. In India, Nirav Modi has his stores in Mumbai and Delhi.
And he is now one of the primary accused of an ongoing investigation where the CBI is acting on a complaint from the Punjab National Bank, a state banking institution, that alleges Modi and his partners defrauded the bank for ₹280 Crore (approximately USD 40 million) by conspired with bank officials to fraudulently obtain Letters of Undertaking for making payments to overseas suppliers.
Should we talk about the poor quality of roads, problems related to access to quality healthcare, literacy rate, unemployment, caste-class issues among other things to explain the gravity of the situation? Well, probably we don’t need to. Dude, “did us” and is likely that he will never call back.
First, The Concept
Let’s understand how things work.
Some importer, let’s call him Nirav Modi or NM, wants to import pearls or diamonds and then sell them. The purchase requires money, so NM approaches a bank, say Punjab National Bank (PNB).
PNB says look, I’ll give you a loan but it will be like at 10%.
NM thinks hard and says, no, that’s too much. Wait, why don’t I take a foreign currency loan instead, after all I’m buying in dollars? Much lower interest rates no? I can get at LIBOR+2% and LIBOR is like 1.5% so I’ll have the money at 3.5%!
But who will give NM a foreign currency loan? A bank abroad? They don’t know NM. They don’t have any history of NM, so why will they give him money?
SO NM goes to PNB and says, boss, you’re my banker, so please help some foreign bank give me some money to buy diamonds. Say that you will guarantee my loan by giving me a “Letter of Undertaking” (LOU).
PNB now should be saying look, if you want me to give Rs. 100 cr. guarantee, you give me stuff worth 110 cr. at least. As collateral.
But PNB, for some strange reason, doesn’t ask for collateral. More on that later.
So now the foreign bank is ready to lend NM the money. Because PNB will guarantee it. And the foreign bank trusts PNB. Why does it trust PNB?
Because PNB sends a message on SWIFT – the banking message service – that PNB guarantees Rs. 100 cr. of money for 180 days for Mr. NM at an interest rate of, say, LIBOR + 2%. It’s like a message – written in stone, effectively – that says PNB will pay if NM doesn’t pay.
In fact the foreign bank trusts only PNB. So it gives the money to PNBs account with it, called by PNB as a “Nostro” – the account that PNB maintains with banks abroad, where the other bank will send money meant for PNB customers.
PNB’s nostro account gets the money.
PNB then gives NM the money from the Nostro account, usually paid off to whoever NM is buying his diamonds from. This payment is to someone outside India usually, to fund a purchase of diamonds or whatever.
Note this carefully: The other bank gives money to PNB’s Nostro account. Not to NM. They don’t care about NM. They only know that PNB has given a guarantee on the SWIFT channel.
Note: the other bank is nowadays mostly the foreign branches of Indian banks. Because the phoren banks have realized something sinister – that PNB’s guarantee is a strange beast that isn’t backed with much, but we’ll come to that
The foreign bank couldn’t care less about whether NM was buying diamonds or bitcoin – to them, PNB would pay back even if NM’s bitcoin wallet got stolen.
Why does PNB give a guarantee? Fees. Each year, a bank may charge upto 2% to give the LoU.
So What Happens When It’s Time To Pay Back?
NM has to get the pearls in India, sell them, receive the money and pay PNB. On the due date written on the LoU.
Then PNB will pay back the foreign bank saying okay, we got the customer’s money so we’re giving it back to you. With interest etc.
That’s what is supposed to happen. But in reality, things went a little berserk, it seems.
The Reality: A Bit of a Ponzi
NM might not pay back at all. NM might use the money to speculate in the markets. Or do something else.
What if NM in the above example simply didn’t have the money to pay back? Instead, he asks a PNB official to open ANOTHER LoU. For the amount owed plus interest. So if we had the first LoU at $10 million the second one is $11 million to cover the interest on the first.
The money from the second LoU is used to repay the first. It’s just rolling over of credit. Over and over. Standard definition of a ponzi scheme.
This can easily balloon into a larger amount, so large that it’s too much. In effect many such arrangements have turned into semi-ponzi schemes, with one LoU being opened to repay another and so on.
Which is what is likely to have happened.
We don’t know the details, but it looks like:
Nirav Modi took loans from foreign branches of Indian banks through an LoU issued by PNB
This was done through a SWIFT based LoU issued through a rogue employee (or many of them) at PNB
The orders never showed up in the core banking system for monitoring
LoUs were rolled over all the way since 2011, and possibly increased over time too.
The rogue official retired in 2017, and the replacement refused to roll over the LoU which came due in Jan 2018 because he couldn’t find the past transactions in the system
No rollover means a default, since there was no money to pay. So PNB quickly files an FIR saying oh goodness we have lost 280 cr. on the Jan LoUs
Then someone said, “Abeyaar, is there more of these not-in-system LoUs? Someone check no?”
Then someone checked.
Oh gawd. 11,400 crores. or is it 60,000 crores?
That’s a lot of crores.
Everyone in the bank panicked.
Why couldn’t Nirav Modi just pay it back? He must have the original money no?
Because if it was ever intended to be paid back, the rollovers wouldn’t have been required. At some point, things got so out of hand that rollovers were required in order to stay current.
Typically this would not be a problem. If PNB had done things right, they would have had collateral worth the amount of guarantee, and they would have sold that collateral and paid the foreign bank.
But, and here’s the real issue: PNB didn’t have any collateral.
Why did PNB give a guarantee without collateral?
If you and I go for a loan to a bank, they’ll ask us for income proof, and collateral. Only small tiny personal loans and credit card loans come backed without collateral. For something of the order of 11,000 cr. you would think they would ask for collateral.
Especially after the scene with Mallya where loans to Kingfisher were given on nearly no collateral (though even there they had a house and some promoter shares pledged)
Why did PNB give this guarantee then? It’s typical – banks give guarantees for more the amount you give as collateral. Because business relationships etc. And then:
Because nearly every bank is doing it.
The loan was not a “fund based limit”. In a fund based limit like a term loan, the bank pays out money. In non-fund-based limits, the bank will only pay if someone else defaults or an event happens – like a Bank Guarantee or an LC or an LoU.
Meaning, PNB assumed that the foreign bank was giving a loan directly to Nirav Modi and that PNB needed to pay only in case Nirav Modi defaulted. So in the eyes of PNB it was always an “non-fund-based” loan.
But this is how a significant part of import financing works. They all rollover credit, and they all use LoUs for much higher than they can offer as collateral.
From my sources, the scale is huge. For every Rs. 100 that a bank has collateral, they will easily provide LOUs for upto 6x the amount. This is a real problem – that most public sector banks do not keep much collateral against non-fund-based limits given to importing customers.
So even if a bank has collateral, it’s nowhere near enough. And then, such unfunded liabilities are not even reported to RBI!
Basel Reporting: No Disclosure
PNB has “unfunded” exposure of 11,000 cr. they say. But they don’t even reveal it in their latest Basel III disclosure:
The funded exposure to “Gems and Jewellery” is shown at 1860 cr.
Unfunded to the same sector: 842 cr.
This doesn’t even add up. So, in effect, PNB didn’t reveal that it was funding massive quantities of “unfunded, contingent exposure”. They will of course pretend that they didn’t know, because the transactions weren’t in the core banking system.
Did Employees Hide it? Was PNB Responsible or was it a fraud?
Can employees be responsible? Could they have hidden the credit and the rolling over of LoUs? But honestly, how does a 11,000 cr. credit pass muster without top management realizing it?
Think of it – your nostro account with these other banks keeps getting big credits that add up to 11,000 cr. Will you not reconcile it in the accounting? The “why is this money even here?” question should have been asked by someone who audits accounts, one thinks?
And the SWIFT messages. It’s a specific kind of message. Why wouldn’t PNB audit the SWIFT trail? Reconcile it with the core banking system? How many more such skeletons will tumble if they do?
Their excuses are
Data wasn’t entered into the core banking system. (Of course, otherwise you would have had to report it)
LOUs weren’t authorized. (Hard to believe, because the amounts are very large. Surely someone on the top would know?)
The SWIFT system was illegally used. (Again, hard to believe that a bank like PNB would not audit its SWIFT messages regularly. Or its auditors. Or RBI.)
On the face of it, it looks like the ex-employee is being used as a scapegoat. It’s likely that a lot of people were in on this thing. And that it generated massive, fat fees for PNB all these years.
Fees wise: Imagine 11,000 cr. worth LoUs being renewed each year – that’s upto Rs. 200 cr. in fees that was all hitting PNB’s top line. You could bribe an employee to maybe give you a small increase – say 10-20 cr. but when you hit numbers like 11,000 cr. this is surely something the top management would know.
What’s the Scale of this scam?
While PNB reported it as a 11,000 cr. scam, they filed an FIR with the CBI for only Rs. 280 cr. This has probably expanded since then but even if the total outstanding is as much as that, there’s a good chance that the actual loss amount will be lesser.
All of it will be borne by PNB right now. Whether someone abused their SWIFT usage is not relevant, if PNB’s SWIFT message said they will pay, they have to pay if there is a default.
But think about the fallout. The problem was that some liabilities were not in the system. There could be more such LoUs. From the same branch or others. Other banks could have such LoUs too. It’s trivial to start looking – and we know that Nirav Modi will not be an isolated case.
Also, the issue was that the limits had no collateral behind them. If all banks are told to verify their non-fund-based limits and demand collateral against them (say at least 25%) then the scale would be absolutely massive. It’s not like this is happening only with Nirav Modi or Choksi. A very large number of importers of commodities have been doing this, and rotating credit. A change in regulation here can change the game dramatically for every other bank (and import account) in the system.
The simple point: this particular transaction will result in a lower loss than 11,000 cr. for PNB. Because of recoveries and such. But if RBI asks all banks to pull up collateral on such lending and stop such practices, the scale is many times larger.
What about the PNB stock?
It’s fallen 17%. But note that it already has 60,000 cr. of gross NPAs. Another 11,000 cr. will hurt it but not kill it. It won’t die – the government will take it over. Shareholders might suffer, but come on as a shareholder of a public sector bank you’re used to suffering.
The problem really is: There is never just one cockroach. When you go deeper, you are likely to find more dirty, dark secrets, and none of them will be any good.
PNB is gonna hurt for a while, but so are others who will find their books similarly tarnished once they investigate.
Will This Bring The Market Down?
Have you been living under a rock? Nothing will ever bring the market down, nowadays.
But the one thing that does bring markets down is the outflow of liquidity. What if so much of the “ponzi” credit – essentially money that was rolled over very month – is being invested directly, or indirectly, into stocks? If RBI tightens up, liquidity will pull money out of stocks, and that will hurt.
Of course, this hurts the fiscal deficit since PNB has to be rescued. So bond yields are up to 7.6% and therefore we’d avoid any long term funds or bonds. Short term it will have to be.
But overall, we wouldn’t worry too much. Just react, don’t predict. What would you do if stocks fell? Better to answer that than to say they will, or they will not.
(And no, not buying PNB)
Our View: Fix it.
This is the Indian public sector banking system. Fix it.
How can you have transactions on SWIFT outside CBS? Fix it.
Why would you not reconcile the nostro accounts? Suspend the auditors. Fire top management. Fix it.
Telgi, Harshad Mehta, Saharashree could not run away, but these guys did. Are they simply smarter or we have just become ignorant? Oh, by saying “we” I don’t refer to the public (who apparently should know everything, yeas a little touch of bollywood is extremely important here, you know Priyanka is worried!)
Do I know the solution? Yes, just fix it. Put them in prison. Take the money back, and don’t harass or depress us anymore with some additional burdens which we can’t afford.
“Banker to the Poor” is a story which ended with a Nobel Prize for Mohd. Yunus, we are yet to witness what “Making Banks Poor” will do to Nirav and his alike.
I guess I should just share another whatsapp message now:
“Ravi Subramanian ‘s fictional book (In The Name of God – Penguin) that released last year was about a banking fraud story.
The main fraudster was a powerful jewelry trader by the name Nirav Choksi.
Nirav Choksi was India’s most exclusive jeweler whose high flying clientele included half of Hollywood and India’s socialites.
The 2 main jewelers in the current PNB fraud story are Nirav Modi and his mama Mehul Choksi. Nirav Modi is/ was India’s most exclusive jeweller. Is this a coincidence??”
Ashish Kumar Singh is a Doctoral Candidate at Political Science Department of Higher School of Economics- The National Research University, Moscow. He can be reached at- [email protected]