The alleged Punjab National Bank fraud, at around Rs 11,400 crore according to initial estimates, is the biggest such in recent times. As in the past, the involvement of politicians as well as senior officials of the public sector bank, the Reserve Bank of India and the central government is alleged. What is certain is that it would be difficult, if not impossible, to separate fact from fiction in this case. As such, its “core part” at least will likely remain in the realm of speculation. That is not desirable as innuendo and accusations can never lead to a concrete plan of action for reforming the banking sector which is badly required now. Similar experiences in the past have led to half-baked action points, nearly all unimplementable, or deliberately sabotaged before they could be followed through.

The modus operandi of the PNB fraud was not novel. Like most similar cases, there was collusion by the staff and the checks and balances integral to any banking system were breached. A few employees at PNB’s Brady House branch in Mumbai issued letters of undertaking, or LOUs, guaranteeing to repay loans taken by the jeweller Nirav Modi abroad. But can two or three mid-ranking officials connive with big businessmen to siphon off huge sums without anybody else knowing?

The expression “systemic failure” haunts the banking system, especially state-owned banks which account for nearly 70% of India’s banking business. If staff collusion is admittedly common, each major crisis has its own ingredients. The 1991-’92 securities scam of Harshad Mehta involved manipulating the tardy systems and procedures of major banks doing treasury business as well as the Reserve Bank. As investigations later revealed, the staff of major treasury banks had been involved. That it is yet to be fully unravelled after over 25 years shows how complex the scam was. Still, because the broker-banker nexus responsible for the scam occupied public imagination, the government had to reform the Securities and Exchange Board of India and capital market intermediaries. What should the PNB fraud lead to?

Anatomy of a fraud

The PNB issued LOUs – bank guarantees really – to Nirav Modi and others without collecting adequate collateral and margins. Further, the complicit staff provided the facilities through SWIFT – or Society for Worldwide Interbank Financial Telecommunication, a global system for banks to securely exchange information about financial transactions – without marking a lien for the bank. So, effectively, Nirav Modi and others enjoyed clean facilities on a massive scale without having to bother about collateral and the like. LOUs are contingent liabilities of the issuing bank, in this case the PNB. No way could the issuing bank feign a lack of understanding of the SWIFT mechanism, which is widely used in global business transactions.

That the PNB gave such leeway to the borrowers for years points to the absence of job rotation in the bank and the complete failure of its management information systems. When some employees are kept in their seats for too long, collusion with an unscrupulous borrower may be just a step away.

Then there is the question of how Nirav Modi could execute such a major fraud. Media reports speak of him enjoying utmost credibility with banks and business partners. Trust is crucial to any business, but especially one with such vast global connections as the jewellery business. This riddle is going to be difficult to unravel. One explanation could be that there is no limit to human greed.

The management of the PNB, and indeed of most public sector banks, has much to answer for. It is certain that low-ranking and mid-level PNB staff were awed by the aura of Nirav Modi and other such people. Experienced bankers insist that such an “inferiority complex” exists among “junior staff” and that it can be exploited by their clients. Indeed, examples of this are all too common, such as how multinationals beat down the interest rate in a consortium advance. By dangling new business and promising to help the operating staff achieve their target numbers, the borrowers strike a hard bargain all the time.

This sense of inferiority among employees cannot be rectified overnight, certainly not without reassessing human resource practices of public sector banks. The government’s efforts at reforming public sector banks have so far involved opening most of them to the capital market and bringing in managers from the private sector. None of these have proved to be the magic bullets it was hoped they would be. The belief that consolidation and mergers can solve the banking crisis is equally misplaced. It is well known that the PNB’s forced takeover of the New Bank of India in 1993 was a disaster, dragging down the PNB’s standing by a few notches. The country’s second largest bank deserves a better deal and, for now, better understanding.

CRL Narasimhan is a former banker and journalist.