The allegations against Nirav Modi have similarities with earlier frauds, such as those perpetrated by Harshad Mehta and Ketan Parekh, in one important respect. They have used loopholes in interbank transactions to get money for short periods. Such episodes are quite different from the bad loan crisis that has enveloped the banking sector, since it involves direct lending of depositor money rather than interbank coordination.

The main reason why the interbank market can be gamed is that internal controls at bank branches are often weak. However, the overall regulatory architecture also matters. The 1992 scam was possible because the interbank settlement system for government securities was outdated. The central bank subsequently cleaned it up.

It now needs to focus on how information is reported both in case of lending as well as transactions that earn fees. These information flows need to be more transparent as well as more frequent. However, internal controls will continue to be the first line of defence against fraud. Regulation can only be a backstop.

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