Why Mehul Choksi's version of the ₹14,000 cr PNB scam cannot be taken seriously

The banking regulator, Reserve Bank of India's, defence, is that it cannot be present in every nook and corner of every bank to supervise front-desk staff facilitating scams. Nirav Modi is fighting extradition to India from Britain, where he had fled, days before the story of the scam broke, probably inspired by the success of another absconding billionaire Vijay Mallya in resisting extradition to India for his own banking contretemps.

They also serve, who stand and defraud. Thanks to the PNB scam that came to light in March 2018, the public at large got educated on bank Letters of Undertaking (LOUs), Nostro and Vostro accounts, SWIFT messaging and Core Banking Solution.

The way the scam worked was as follows: Nirav Modi and his uncle owned multiple companies in India and abroad, including in Hong Kong, as per disclosure by the Central Bureau of Investigation. The Indian companies imported rough diamonds from foreign companies, including from companies associated with the importers (this led to charges of round-tripping). To pay for the imports, the importer would ask PNB to issue an LOU to another bank that would advance the credit in foreign exchange. PNB issued LOUs to the Hong Kong branches of Allahabad Bank and Axis Bank, essentially saying that in case the importer failed to pay up, PNB would make good the deficit. The bank to which the LOU was issued would credit the amount to an account of PNB with that bank. This foreign account is called a Nostro account by PNB, and the same account is referred to Vostro account by the bank where the account has been opened. Nostro and Vostro mean ‘ours’ and ‘yours’, respectively, and derive from mediaeval Latin, the language of banking in Italy where modern banking originated (banca means a bench, and benches were used as makeshift desks by money dealers by early Florentine bankers).

The LOU is sent out using the SWIFT system of messaging. SWIFT stands for Society for Worldwide Interbank Financial Telecommunications. The society was founded in Belgium by 200 -odd financial institutions from 15 countries in 1973, and more and more banks and countries associated with it over the years. SWIFT does not transfer or settle funds. It only sends out secure messages from one bank to another, and assigns SWIFT Codes to banks. It is ripe for replacement by superior systems of fund transfer, such as blockchain.

Now, when an Indian bank sends out a message over SWIFT, it is supposed to be logged in the bank’s Core Banking Solution (CBS), a complex piece of software that captures all bank transactions. At PNB’s Brady House branch at Fort, Mumbai, some employees managed to send out SWIFT messages bypassing PNB’s CBS. When money was transferred to PNB’s Nostro account, this was not matched by any instruction from PNB, something PNB’s auditors failed to notice. Nor does banking supervisor RBI have any system of correlating, say, Axis Bank’s advance to PNB’s Vostro account with matching paperwork at PNB.

The scam came to light when some Modi-Choksi company employees approached the Brady House branch of PNB for an LOU and the PNB employee demanded 100% cash margin to send that LOU. The diamond dealers told that employee that they have been getting LOUs sent without any margin money being put up. This set off an inquiry. It transpired that since March 2011, the Brady House branch had issued 1,213 LOUs for Choksi-Modi firms, of which 53 that were in order, and the rest fraudulent. When the time came to settle the advance made on the basis of one LOU, another LOU would be issued. So, nominally, these short-term loans extended to Choksi-Modi firms by Axis Bank and Allahabad Bank were all paid off, but through the continuous grant of fresh, unrecorded credit by PNB, whose volume kept growing, to pay for the interest accrued as well. The final outstanding amount came close to ₹14,000 crore.

One particular PNB employee, Gokulnath Shetty, has been blamed, for sending the LOUs with neither matching margin money nor a record in the CBS. How did Shetty manage to stay in the same position in the same branch for seven years to carry out the scam? There has been no clear answer to this question. The only systemic corrective implemented so far has been for all banks to ensure that all SWIFT messages would be routed through the respective banks’ CBS. The concurrent audit of transactions among banks by examining the books of all the banks involved is still a far cry.

PNB has been trying to recover the ₹14,000 crore it had to book as a loss and provide for from its own resources. It has recovered a few hundred crore rupees worth of personal assets of the Modi-Choksi clan. Three years after the scam came to light, the main beneficiaries stay outside the country.

Choksi’s lurid exploits abroad — a tour of Dominica, which he claims resulted from Indian agents kidnapping him, even as another version presents it as a joy ride along with a woman friend — serve as distractions. His fervent declaration of innocence and keen desire to clear up the mess, if only PNB would unfreeze his accounts, and his health would permit, should be seen as part of the drama.

The money remains unrecovered and the accused stay abroad. We, in India, are left with some lessons, however.