Gem of a scam: How Nirav Modi used fake LoUs to defraud PNB of about Rs 11,400 crore

A set of bank officials in connivance with businesses owned by flamboyant diamond and jewellery merchant Nirav Modi exploited information gaps and lax processes in India's second largest PSU bank, Punjab National Bank, to defraud it of money that may add up to $1.77 billion, or Rs 11,345 crore.

Possibly, the amount may be even higher if the modus operandi employed in this fraud is being used in other banks as well. PNB has written to 30 banks as soon as it discovered the fraud explaining the modus operandi, asking them to investigate if they have faced similar frauds. The final number may be known only after the investigation at PNB and these 30 banks is over.

PNB discovered that at least 2 individuals, deputy manager Gokulnath Shetty and clerk Manoj Kharat, from its Brady House branch in Mumbai repeatedly issued Letters of Undertaking (LoU) to Nirav Modi's companies and their banks without following the processes, without securing cash reserve or collateral and without recording the transactions in the bank's core banking software, the system on which the banks's financial transactions are run and recorded. An LoU is a guarantee by the issuing bank to the receiving bank and the companies that it would undertake to pay a certain amount of money on a specific date.

Modi and his companies leveraged those LoUs in Hong Kong to secure buyers' credit from the local branches of Allahabad Bank (estimated to be Rs 2,000-2,200 crore), Union Bank (about Rs 2,000-2,300 crore), Axis Bank (about Rs2,000 crore) and State Bank of India (Rs 960 crore), among others. Between five-six Hong Kong branches of Indian Banks (Allahabad Bank, Axis Bank, Union Bank of India, Bank of India and State Bank of India) are believed to have issued buyers' credit against these LoUs.

These suspect bank officials issued the LoUs and informed these branches via the international cash transfer service called SWIFT (Society for Worldwide Interbank Financial Telecommunication) which connects all international banks worldwide. However, exploiting the information gap-and the fact that unlike other Indian banks PNB had not integrated its SWIFT network with the bank's core banking network- they chose not to record these transactions in the bank's own system.

While Shetty retired in May, 2017, PNB has, meanwhile, suspended 10 officials after its prepreliminary investigation. PNB managing director Sunil Mehta says it approached CBI on January 29 after it detected the fraud. "The fraud was detected in the third week of January and a case was filed with CBI," Mehta said. The fraudulent LoUs were discovered when Modi's companies Solar Exports, Stellar Diamonds and Diamonds R US asked PNB for buyers' credit in mid-January.

The bank official handling the forex desk told them that since they didn't have pre-sanctioned limits, they should provide cash margins or collateral. To that the companies responded by saying that they had been availing the buyers credit in the past. PNB began investigating it at this point. PNBs first complaint was filed on January 29 with the CBI mentioning it as a Rs 280 crore fraud. However, on February 14 it issued another statement saying it detected fraud of $1.77 billion (Rs 11,300 crore).

Observers suspect round-tripping of funds raised from one bank being used to pay up buyers' credit for the other bank in this modus operandi. Over 150 such LoUs were issued since the first one was fraudulently issued in 2011. Interestingly, while an LoU expires in 90-180 days, these bank officials are believed to have rolled them over after each expiry, as a result the fraud lay undetected for over 7 years. In a letter to PNB, Modi is believed to have asked for six months to pay Rs5,000 crore due from him. Since the buyers' credit has been issued against PNB's LoUs, the bank is liable to pay for any shortfall, non-payment by Modi and his companies. PNB's managing director said the bank will honour every payment owed to these banks.

The Enforcement Directorate has raided various premises of Nirav Modi belonging to his entities-Firestar Diamonds, Stellar Diamonds, Find Diamond R US and Solar Exports- all across the country and have seized diamonds, precious stones and jewellery worth an estimated Rs5,100 crore. Nirav Modi, his wife Ami (a US citizen), his brother Nishal (a Belgian citizen) as well as his uncle Mehul Choksi, promoter of Gitanjali Gems, fled the country between January 1 and January 6. Nirav Modi was last spotted at Davos where he appeared for a photo opportunity with PM Narendra Modi right after his address at the World Economic Forum on January 23.