5 Major Mistakes Made By Banks That Cannot Be Ignored

Bank scams are increasing everyday and it only makes me wonder ‘How could anyone possibly, not have caught that?’  Frauds worth Rs. 11, 300 crores don’t happen overnight and definitely can’t go unnoticed. Something, somewhere had to have been compromised for it to blow up so badly. 

Here are 5 mistakes made by banks that just CANNOT be ignored:

 #1. No practice of collateral:LOU

When banks lend loans they ask for collateral or secured assets to honor the loan. The collateral is usually equal to the amount borrowed and acts as a guarantee to the lender. 

Recently, Nirav Modi the diamond trader borrowed loans worth Rs. 11,300 crores from banks abroad (Allahabad bank, Union bank, Axis Bank) against fake LoU’s issued by PNB (Punjab National Bank). The LoU’s are usually issued to importers for borrowing short term loans from abroad against some collateral  equal to the borrowed amount. As per guidelines the maturity period for these LoUs for the jewelry sector is 90 days. But in Nirav Modi’s case LoU’s with 365 day maturity were issued against no collateral. This change in the usual practice of LoU’s should have raised an alarm in the lending banks (Allahabad Bank, Union Bank, Axis Bank) at least if not in the banks issuing the LoU (PNB). But surprisingly, it did not and the banks continued lending loans on the basis of the LoU. 

#2. Not learning from Private banks:SWIFT

In Modi’s diamond scandal the official issuing the LoU had access to the bank’s SWIFT system, through which he sent messages to the foreign banks confirming the LoU’s. All private banks have linked their SWIFT system to the bank’s core banking system (a centralized system that records transactions of a bank carried out from all its branches) due to which SWIFT messages automatically get recorded on CBS. 

But most public banks including PNB haven’t linked their SWIFT with CBS. Because of which SWIFT entries have to be manually entered into the system. This made it easy for Gokulnath Shetty (the employee responsible for the fraud) to skip the manual entries of LoUs in the CBS and such transactions never made it to the books of accounts. When bank audits were conducted they had no clue of these transactions  because there were no records and the fraud went unnoticed. 

#3. Not following standard practices on account of ‘too much work’:

“When you are flooded with customers in the morning, with 101 demands, you look for shortcuts. You do somebody else’s work, somebody else does your work. You are not working in an ideal situation.”says a bank executive who refused to be named.

Ideally all banks must process their SWIFT messages by 4 bank officials: a maker, a checker, a verifier and an authorizer. According to Deloitte, a stronger protocol must be followed for makers and checkers and for verifying and authorizing banks need strong programs to frequently monitor and report messages. But at PNB, Shetty served as both the person sending the messages and the person reviewing them for approval. Allegedly even passwords were shared and the junior officials were made to send messages via SWIFT. When asked about this password sharing the senior PNB executive said it was not best practice but in the everyday bustle of Indian banks it happens. That’s not all, important job positions like Shetty’s are supposed to be rotated but instead he had been working at the same branch for 7 years. 

#4. Not understanding the concept of Once Bitten Twice Shy:

Previously PNB was victim to several frauds by jewelers including 2 of the biggest ones The Winsome Diamonds and Shree Ganesh Jewellers frauds. In these cases PNB was at the receiving end and details of the fraud were presented to all the banks involved, including PNB. The frauds used the same modus operandi (a particular method used for an operation) as the Nirav Modi fraud and the forensic investigators cautioned PNB of the loopholes in their system. They told them about the possibility of fraudulent employees and raised concerns about how such frauds can go undetected in the banking systems. But still PNB did not learn from its mistakes.

#5.  Not monitoring accounts: NOSTRO

RBI has given several warning to banks to check and review their balance statements regularly. But many banks don’t. In Nirav Modi’s  case the money from the loans didn’t come into his accounts but in PNB’s Nostro account. When it was time to repay the loans, more LoU’s were issued rolling over the previous loans. Inspecting the discrepancies in these accounts would have caught the problem but that wasn’t done.

Simply put, PNB’s Nostro accounts were not reconciled or not even monitored. None of the bank’s inspection team, audit team, forex team, CEO, top management or the board of directors (of which some are from RBI and the central government) detected the fraud. Until one day someone from Nirav Modi’s company asked PNB for another LoU and was denied, because Shetty who had been previously granting the LoUs had retired.

And that’s how these 5 mistakes led to an Rs. 11,300 crore massive fraud!


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