THE COLLAPSE OF CREDIBILITY: ANALYSING THE IMPACT OF NIRAV MODI SCAM ON INDIAN BANKING

Abstract

This research delves into the impact of the Nirav Modi Scam, on the trustworthiness and stability of the Indian Banking Sector. The scam came to light in 2018 involving transactions around 12,700 Crore through the misuse of Letter of Undertaking (LoUs) issued by Punjab National Bank (PNB). PNB scam is the greatest bank scam in India. Reserve Bank of India (RBI) which is the Apex bank of the country, facing public call for not being able to find the banks scam. The study investigates fraud regulatory oversight failures and systemic weaknesses that enabled the scam to occur. It highlights shortcomings in risk management, compliance and oversight that allowed the fraud to go unnoticed for a period. Additionally, it assesses the effectiveness of reforms and policy changes implemented post scam. By examining a series of events and their aftermath this paper uncovers broader implications for India’s banking system such as erosion of trust strengthening framework and reputational damage faced by affected financial institutions. It also discusses economic reforms introduced following the scam to gauge their effectiveness in preventing financial misconduct in the future. This study underscores the importance of enhancements in governance, transparency and accountability to rebuild and uphold confidence, in India’s banking sector.

Keywords

Letters of Undertaking (LoU), Punjab National bank (PNB), Reserve Bank of India (RBI), Central Bureau of Investigation (CBI)

Introduction

“Shining Diamond Trader took away the PNB’s shine”.

The Nirav Modi scam, came to light in early 2018, this news shook the nation and sent shockwaves through the Indian Banking industry unveiling vulnerabilities in the financial system, resulting in greatest fraud cases in the Indian history. According to RBI, Fraud is a deliberate act or commission by any person, in the course of banking transactions or in the books of accounts which are maintain manually, which results into wrongful gain to any person for temporary period.

Who is Nirav Modi?

Nirav Modi is a diamond jeweller and designer who learnt about this business for his maternal uncle Mehul Choksi. Nirav Modi was positioned 57 in the Forbes list of very rich people in 2017. He is also the founder of the diamond jewellery retail stores. He is the Chairman of Firestars International, which has stores across the world. He has 17 stores in various locations such as Delhi, Mumbai, Hong Kong, London and Macau. He is currently in United Kingdom and is seeking asylum in Britain.

The Timeline and Mechanism of the Nirav Modi’s Fraud was started from 2011. He did this scam with the help of some other persons including his uncle Mehul Choksi, who was the head of the Gitanjali Group and his brother Nishal Modi. They used their connections and influence within the Punjab National Bank (PNB) to secure the unauthorized Letter of Undertakings (LoUs). Employees of the PNB bank at Brady House branch in Fort, Mumbai, who were involved in this fraud were fraudulently issuing the LoUs. They were misused the SWIFT interbank messaging system for transmitting these LoUs to overseas branches of Indian banks, due to which this fraud was did not appear in the Bank’s core banking system (CBS). These funds were used to import diamonds and several other precious stones. All the issued guidelines were ignored by the overseas banks and failed to share any information with bank. This fraud was caught according to a 2018 article by Hindustan Times, that one of the employees who was involved in this fraud was retired and a new employee joined in his place. When Modi’s firm asked for some guarantees then new employee demanded collateral. The new employee did an investigation where he caught this fraud and truth of thee fraudulent LoUs coming to light. After getting caught about the scam, Nirav Modi and his uncle, brother and his wife flee India and located in the United Kingdom while Choksi is found in Antigua and Barbuda. The legal proceedings for the extradition of Nirav Modi from the UK commenced.

This research paper aims to find the intricate details of the scam, analyse its effect on banking credibility and identify the systematic failures due to which this fraud occurred. Through a strict analysis, this research will contribute to the ongoing discourse on enhancing financial oversight and fortifying the resilience of banking institutions against future frauds.

Research Methodology

The research is based on the secondary sources and outlines the systematic approach to analyse the impact of the Nirav Modi Scam on the credibility of the Indian banking sector. The research is descriptive and aims to provide deep insights into perceptions and impacts of the Nirav Modi Scam. The secondary sources of information like official reports, financial statements, news articles, journals, websites and some regulatory documents related to the Nirav Modi Scam.

Review Of Literature

The Indian banking system has gone through significant transformations over the past few years. There are many researches available in the area of financial frauds in the banking sector. As the survey conducted by Ernst & Young,2012, the financial frauds in banking sector increased by 84%. People expect transparency, accountability, fairness and effective intermediation from banks. People’s faith is one of the most challengeable task for modern day bankers. As the scams are increasing day by day the people’s faith in the banking institution also decreasing. This scam is the 2^nd largest financial scam happened in India.

Objective of study

The objective of this research is –

To study the credibility in banking.

To inquire about frauds in the banking sector.

To determine the impact of frauds on performance of banks.

To identify how frauds impact the profession.

Credibility in Banking prior to these frauds

The credibility in banking means the degree of trust and confidence which customers and the stakeholders have in a bank’s integrity, reliability and the ability to fulfil its obligations. Every citizen earns money very hardly and keeps money in the bank accounts with the trust that his money is safe. Prior to these bank frauds, the Indian banking sector enjoyed a strong reputation for credibility and reliability. Banks were seen as the pillars of financial stability and development through extensive networks and robust customer bases. Reserve bank of India played a critical role in maintaining this credibility by the strict regulatory frameworks, regular audits and maintaining financial discipline within banks. The RBI designed the policies to reduce the risk and promoted good governance to uphold the integrity of banking system. RBI’s guidelines on provisioning norms and rules and capital adequacy requirements were pivotal in ensuring that banks remained solvent and capable of absorbing financial shocks.

Frauds in banking sector

The financial frauds or scams have long lasting repercussions on the banking sector, destroying public trust and the financial stability. The Nirav Modi Scam is not a single fraud in India, some other frauds which includes Harshad Mehta Scam (1992) and the Satyam Scandal (2009). These scams were also the reason of immediate fallout and the long-term impact on the banking system and regulatory practices.

Nirav Modi; detailed Case Study

The Scam done by Nirav Modi is one of the greatest frauds in the Indian banking history. Nirav Modi was a jeweller and designer, with the help of his uncle, brother, wife and some employees of the PNB bank at Brady House in Fort, Mumbai did this huge scam from the early of 2011.

The PNB employees who helped Nirav Modi by issuing of the fake Letter of Understanding (LoUs). These LoUs were in favour of Indian banks for the import of diamonds and other precious stones. The guidelines issued by the RBI were ignored the overseas branches of the Indian banks. They also failed to share information or any document with PNB. The Enforcement Directorate recovered the devices of foreign dummy companies which were used by Nirav Modi for transferring the fraudulent funds. The Enforcement Directorate seized all the properties which are related to the accused.

The question raised, How the PNB management do this? The employees who were involved misused the SWIFT network for transmitting the messages to the other banks on fund requirements. The transactions were never recorded in the bank’s Core banking system (CBS), and kept them in the dark for years.

This scam was unfolded in 2018, when one of the involved employees get retired and a new employee joined in his place. The diamond firm asked for a new LoUs, the new employee asked about the collaterals but the firm said that they were doing this earlier without any collaterals. The employee started to inquire all this and he got to know that there were no recordings in the bank’s core banking system. On 29^th January 2018, PNB lodged a FIR with CBI stating about the fraudulent LoUs. In the complaint, PNB named some Diamond firms, solar exports and Stellar Diamonds.

Persons who were involved in this scam were: Nirav Modi (owner of the Nirav Modi firm), his wife (Ami Modi), brother (Nishal Modi), uncle (Mehul Choksi), PNB employees (Gokul Shetty, Manoj Kharat).

After the news of getting caught, Nirav Modi flew from India, his uncle, wife and brother also flee India. In March 2019, Nirav Modi was arrested in UK and the legal proceedings for his extradition is still in process.

Impact of fraud in banking sector

The large-scale scams or frauds, have profound the impact on the credibility of the banking sector. These frauds affect the various aspects of the banking operations, stability and also the public trust. The effects are categorised into some points-

1-LOSS OF CUSTOMER TRUST, customers start questioning about the safety of their deposits and the integrity of the bank’s functioning. After the bank’s security compromised, customers may withdraw their funds which can lead to liquidity crisis. After this fraud, people started to move towards the private banks rather than the government banks.

2-FINANCIAL STABILITY: due to these fraudulent activities lead thee bank towards the financial loses which affects the bank’s capital adequacy ratios. Due to which the bank will not able to lend and support the economic activities, which were seen after the Nirav Modi Scam. The scam impacted negatively on the Indian economy.

3-STOCK MARKET REACTION: the stocks of the PNB bank declined which affected the confidence of the investor and the overall stability of the financial market. The sudden volatility in the prices corded the market cap of these 34 stocks by over Rs.36,860 crores. Not only the stocks of PNB bank got affected but also some other institutions affected including Union Bank of India, Allahabad Bank, Axis bank and State Bank of India. The stocks of all these banks were also affected by the scam.

Impact of fraud on Profession

The employees who helped the accused in the fraud also affected the other employees related to their job security, career prospects, professional integrity. Financial frauds damaged the integrity of the banking professionals. When such high-profile fraud cases expose, then the entire banking profession is viewed with suspicion. There is greater impact on the ethical behaviour. The fallout of such major frauds leads to a contraction in the banking industry which affects the career prospects of banking professionals, specifically in those institutions which are directly involved in fraud. Due to the active participation of bank in frauds also leads their employees towards the job insecurity. This insecurity can lead to decline in job satisfaction among the banking professionals.

Suggestions

Based on the research and findings from the analysis of the impact of the Nirav Modi Fraud in the Indian banking sector, some strategic suggestions can be made to enhance and restore the credibility of banks. These suggestions focus on improving the regulatory frameworks, strengthening the internal control of banks, enhancing the transparency and rebuild the customer trust.

1-ROLE OF GOVERNMENT: The Government plays a crucial role in reducing the bank frauds in India. Here are some of the ways by which the government contributes to reduce the banking frauds:

Supervisory Control- The Government agencies and the regulatory bodies such as Securities and Exchange Board of India, and the Ministry of Finance look over the banking functioning to ensure compliance with the laws and regulations. Bank has to follow the framework such as, they have to ensure about the KYC to have the accurate and verified information about their customers. There must be the Anti-money Laundering Regulations for detecting and preventing the money laundering activities.

Legislative Measures- the Government should enact the laws which aim to reduce the banking frauds and enhance the legal framework for prosecuting the offenders. These measures include, The PMLA,2002, the Companies Act,2013 and the Fugitive Economic Offenders Act,2018.

Enforcement Actions- the Government should have to conduct thorough investigations into allegations of fraud and bring cases before the court for ensuring the perpetrators are held accountable.

Transparency and Accountability – the Government encourages transparency and accountability within the banking sector by some initiatives such as, mandating banks for adopting best practices in corporate governance, requiring banks for disclosing the financial information to stakeholders which increase transparency.

Cybersecurity- The Government promotes the use of technology to enhance the detection and prevention of fraud which includes –

Issuing guidelines to secure digital banking practices
Establishing the Financial Intelligence Units to analyse all transactions

2– STENGTHENING REGULATORY FRAMEWORK: The RBI plays a pivotal role for maintaining stability and the integrity of the financial system. The RBI should implement regular audits and surprise inspections of banks which can help in identifying vulnerabilities and prevent frauds. The audits provide an evaluation of bank’s financial health. Bank should boost their risk management frameworks for better identification and reducing the risks. For which, they have to provide training to employees at all levels to understand the importance of risk management and encourage them to report any irregularities in their respective banks. The RBI has to establish a centralized fraud registry for recording and tracking frauds which will help in sharing information. RBI should closely monitor bank’s adequacy ratios, assets qualities to ensure that they remain within safe thresholds. The RBI should have to lay down a proper criteria for the appointment of directors and senior management in banks. These must ensure about the integrity and competence of an individual. The RBI should also conduct the public awareness campaigns for educating customers about the safe banking practices and also the importance of reporting any suspicious activities related to fraud.

Conclusion

This research paper has delved into the multifaceted impact of the scam. Due to Nirav Modi scam, the Indian banking sector loses its credibility and highlighted the vulnerabilities in the system. It is also surprising that this scam had not been identified even during the external audit process for a period of seven years. This scam exposed many banks to the credit risk. This scam struck as the earthquake in India’s banking sector. All the customers of the bank who deposit their savings are in shock and in stress for their hard work money. The key findings focused on the critical need for the systemic reforms and strategic measures to restore and enhance the integrity of the banking sector. This scam found some gaps in the regulatory oversight where the existing mechanism failed to detect and prevent fraudulent activities in a particular manner. The Indian banks are still following the oldest system which is not adequate to prevent financial fraud. It is correct that many reforms were introduced such as, Fugitive Economic Offenders Act,2018, strict regulation and guidelines were issued by the RBI and the Government for preventing future bank frauds. India’s economy is being rocked by this banking scandal which also affected the respect of India at International level. The banking sector is constantly hit by the frauds which indicate the internal risk management is very fragile and non-planned. The reputation of the banking sector is at stake, at that time when the global attention is focused on stabilising the bank reforms and the efficiency of financial sector. The banking’s regulatory framework may be amended and the Government should also make legislative frameworks for the prevention of such frauds and also the penal provision be very strict for the offenders who try to do such frauds in the future. The government may have to rework its capital infusion plan in the light of these bank frauds. Additionally, by improving the cybersecurity measures which is important to protect against the increasing threats of digital frauds in the era of digitization. The collaborative efforts of the Reserve Bank of India, individual banks and the Government will be vital in preventing the future frauds. Through these concerted efforts, the banking sector can emerge stronger and trustworthy also, which ensure the integrity and the stability of the financial system in the future.

References

AUTHOR:

Prateek Yadav

Law College Dehradun (Uttaranchal University)

THE COLLAPSE OF CREDIBILITY: ANALYSING THE IMPACT OF NIRAV MODI SCAM ON INDIAN BANKING

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