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Same old story? How banks ignored alerts

February 16, 2018 12:11 IST

IMAGE: The Punjab National Bank branch where fraudulent transcations worth USD 1.77 bn were detected, in Mumbai. .
Photograph: Shirish Shete/PTI Photo.

Despite the rating agency CARE withdrawing the ratings assigned to the bank facilities of FIPL “with immediate effect”, Modi’s company received uninterrupted letters of undertaking from PNB, which were honoured by other banks until a few weeks ago. 

Banks led by Punjab National Bank ignored crucial warnings by CARE Ratings in February 2016 that Nirav Modi’s flagship company, Firestar International Private International, had a high leverage, large off-balance sheet exposure and limited customer and geographical spread. 

But, in a curious turn of events, on June 7, 2016, the rating agency said it had withdrawn the ratings assigned to the bank facilities of FIPL “with immediate effect” following the receipt of a no-objection certificate (NOC) from the banks. 

Modi is the prime accused in an alleged bank fraud of Rs 113.6 billion, revealed by PNB on Wednesday. 


“Why these banks issued the NOC to withdraw ratings at a time when the company was going downhill needs to be investigated,” an executive with the rating firm said, requesting not to be named. 

Despite this early warning, Modi’s company received uninterrupted letters of undertaking (LoUs) from PNB, which were honoured by other banks until a few weeks ago. 

According to data submitted by FIPL to the regulators, the company posted an operating income of Rs 41 billion and profit after tax (PAT) of Rs 990 million in the financial year ended March 2015. 

And for the first half of 2015-16, Modi’s company reported Rs 14.58 billion as income from operations and Rs 260 million PAT. It stopped issuing financial details thereafter. 

In a statement on February 1, 2016, CARE warned that FIPL had been operating on a stretched operating cycle till March 2015, which had led to working capital bank facilities being fully utilised at a time its operational performance was on a decline. The agency then downgraded the company’s debt instruments worth Rs 24.6 billion. 

CARE also warned about Firestar Diamonds Ltd, a subsidiary based in Hong Kong, saying the company might not be able to repay its loans unless its parent company stepped in as a guarantor. It also issued a similar statement on Firestar Diamond International Pvt Ltd (FDIPL), another company set up by Modi in India. 

Interestingly, Modi and other Firestar group companies were guarantors to the facilities of each other and had assured banks that they would make good any shortfall in the debt servicing obligation of FIPL on demand. FIPL had extended similar corporate guarantees to the bankers of FDIPL for timely servicing of bank facilities, resulting in a cross-guarantee structure. 

In 2006, Modi set up FDIPL to focus on the group’s jewellery exports business operations and establish manufacturing units in Surat’s special economic zone and in Maharashtra Industrial Development Corporation (MIDC), Mumbai. 

In 2014, it also set up two retail outlets in Mumbai and Delhi to sell jewellery brands like “Auctions” and “Nirav Modi Jewellery”. According to the available data, FDIPL posted sales of Rs 15.61 billion with a PAT margin of just 3.91 per cent in 2014-15. In the first half of 2015-16, FDIPL posted revenues of Rs 7.40 billion. 

Jewellery industry sources said there were clear signs that the company was in financial distress and Modi was raising funds from every source possible. The company even toyed with the idea of raising funds via an initial public offer (IPO) in the middle of 2017 but the plan failed as its financial metrics deteriorated. 

Modi’s flagship firm, Firestone International Pvt Ltd, was incorporated in 1997 and was renamed FIPL on September 28, 2011. FIPL had two verticals: Studded jewellery, which formed 80 per cent of its revenues in 2014-15, and cut and polished diamonds.

Dev Chatterjee

People, not processes, responsible, say bankers 

The alleged fraud at Punjab National Bank has raised questions over the processes and systems in public sector banks, but bankers say there are a number of reasons why it’s always the PSBs that seem to be affected, whereas private and foreign banks seem to be the most efficient. 

To start with, the sheer size of the market the PSBs control makes them vulnerable to determined frauds. About 70 per cent of the banking system is controlled by PSBs, and by extension of that, most of the frauds get optically tilted towards these banks, say bankers. 

These banks are also present in every nook and corner of the country, and the people manning them may not be that sophisticated. Many works are still done manually in these banks and vulnerabilities creep in, they say. 

Besides, the quality of employees that PSBs attract these days is not always top grade, and the compensation paid to them is pittance. For example, a clerk in a PSB gets stuck at a monthly payment of Rs 20,000, whereas a probationary officer starts at Rs 30,000. 

Top quality people, therefore, are reluctant to choose banking as a career. Most of these people move to private sector banks, if at all, where the chances of rapid growth, albeit in a high pressure environment, are more. 

“Earlier, banking was the only decent choice, now it is one of the last. The calibre of the staff we observe now is quite low,” said a senior bank official of a public sector bank. PSBs are also severely understaffed, and this hinders proper training. 

“The priorities of branches are very different than the priorities of the head office. It is a rule that we need to send everyone for a two-year training. But if I send one of my people manning the teller, my operation gets hampered severely for many days. Thus, effective training never happens,” said the official. 

However, even if the training happens, it is not very serious and doesn’t add much value. 

“I was sent on a week’s training at a foreign location. It was more like a picnic,” said the official. 

And then, there are issues around the quality of business that the banks seek in foreign offices. Since the Indian banks are not the dominant bank there, and the branch manager is in immense pressure, the bank does business with poor quality clients, often rejected by other established local banks. There is always a chance of a fraud or bad debt in such cases. 

Bankers also say it is the nature of the business of public sector banks that makes them susceptible to fraud. For example, private banks are retail focused, whereas public sector banks are corporate focused. 

The biggest banks in the country, such as State Bank of India, PNB, Bank of Baroda, and Bank of India, can afford to issue loans of hundreds of millions, but smaller private banks cannot take exposure in those assets because of limitations of their balance sheet size. Therefore, when there is a fraud or bad debt happening in these accounts, it is always large in size. 

There are also issues of underwriting practices, which varies from bank to bank. 

“It is not right to paint all banks with the same brush. State Bank of India will never give the kind of loans that other banks in the system will be ready to give,” said Pratip Chaudhury, former chairman of SBI. 

“Banks vary in their culture as well. SBI has developed its culture, has better training facility, and better accountability, which many other banks lack,” Chaudhury said, adding private banks also face frauds, and in cases such as PNB, if guarantee, which is a non-fund based exposure, is issued without even the system of the bank knowing it, it is quite difficult to prevent such a fraud. 

And therefore, more often than not, it is the people and not process that drives a bank and prevents malfeasance. But too much of tightening of the process would also hamper the smooth functioning of a bank. 

“If the government has to enforce stricter controls saying that only certain people will have access to data would only make the process more cumbersome,” said Deepak Bhawani, CEO, Alea Consulting, a fraud prevention consultancy firm.

Anup Roy and  Nikhat Hetavkar 

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