The mainstream narrative in the Punjab National Bank-Nirav Modi fraud runs something like this: two, or three, lower-level officials in the bank, in cahoots with the diamantaire, used the Swift system for inter-bank messaging on fund transactions to make crores available to Nirav Modi for his imports of precious stones, and they kept the transactions outside the purview of the bank's core banking system. Letters of Undertaking (LoUs) were issued in favour of the diamantaire, thus guaranteeing any loans given to him by another bank.
In theory, thus, the scam could have been perpetrated by lower-level officials, since the top bosses would not have known of this way of keeping dubious deals backed by no collateral out of the books. However, this easy reading of a scam possibility that the top manag-ement did not know about, flies in the face of facts.
First, the decision to keep the same person, Gokulnath Shetty, in the same position in the same branch for more than six years could not but have been a top management decision. Second, it needs not just two people, but four officials to connive in this kind of fraud. Any Swift transaction needs four persons to be in cah-oots: the first person keys in the transaction message, a second one checks it, and the third person authorises it. And once the message is sent, a fourth person receives the confirmation from Swift. In short, four persons are required - and it is impossible that no one senior to these four had any clue that they were in it together.
Lastly, in a press release put out on February 20, the RBI said that it had been warning banks about the potential for Swift misuse. The press release said: 'The risks arising from the potential malicious use of the Swift infrastructure, created by banks for their genuine business needs, has always been a component of their operational risk profile. RBI had, therefore, confidentially cautioned and alerted banks of such possible misuse, at least on three occasions since August 2016, advising them to implement the safeguards detailed in the RBI's communications, for pre-empting such occurrences. Banks have, however, been at varying levels in implementation of such measures.'
One does not know if PNB was one of the banks receiving such confidential warnings, but even if it wasn't, the takeout is clear: there is no way top managers in the bank could not have known of this opportunity for misuse of Swift. And even if the technology wasn’t ready for integrating Swift transactions with the core banking solutions, the banks could have put temporary manual safeguards and oversights in place to prevent frauds.
The implications of the above facts are simple and straightforward: these gaps in safeguards are left deliberately in the grey area to facilitate high-risk activities in a way in which no one can be directly implicated. Everybody can then throw up his hands and say the technology does not support these checks and balances, and some low-level scapegoat can be sent to jail. And remember, it is not necessary that all frauds result in losses to banks, forcing them to close the loopholes in their systems. As long as the imports and exports resulting from non-collateral-based lending are profitable overall, even crooks return the money to the bank (and then re-borrow when required). And everyone is happy. It is only when things go wrong, and the fraudster actually makes losses, that the banks find themselves in a hole. Put simply, scams exist because when the winds are favour-able these loopholes benefit both banks and their fraudster customers. It is only when things go awry that the fraudsters scoot with the loot and the banks are left high and dry. Since such scams can take years to fail, it means the original perpetrators at the banks would have retired or been transferred, and can well deny knowledge, just as current top bosses can also do so, saying this happened when they were not at the helm, and thus they learnt about it only now. The entire process is intended to give all top managers the option of plausible deniability about involvement in the scam.
A corollary that follows is this: scams are not always the result of crooked bankers taking bribes to earn illegal gratification from crooked businessmen. Sometimes, these bankers may see short-term benefits for their banks in colluding with crooks, without taking the risks of such collusion into account.
The Harshad Mehta and Ketan Parekh stock market scams of 1992 and 2001 explain why this is so. In 1991-92, when liberalisation pushed up interest rates on government bonds, banks faced huge losses on their existing bond portfolios, which sank in value. In this scenario, Harshad Mehta may have offered to improve returns on bonds through alleged ready-forward (today's repo) deals, when the money was often deployed in stocks. When the markets are booming, stocks will obviously outperform bonds by a wide margin, and many bankers may have seen Mehta as a saviour rather than a scamster seeking to make a pile by using money market funds in the stock market. At some point, he used fake bankers' receipts to raise even larger sums from unwary bankers, leaving them with huge losses when the music stopped and the stock markets crashed.
A similar ruse was at work in 2001, when Ketan Parekh, another stock market operator, used fake bank pay orders from the Madhavpura Cooperative Bank (MCB) and discounted them with the Bank of India to raise money for his stock market capers. This would have benefited both MCB and Bank of India, since both would have got higher returns on their banking services from Parekh. Again, when the markets crashed, the scam was outed as it was soon discovered that MCB did not have the funds to issue pay orders worth more than `100 crore, and BoI was left holding the sack.
The obvious conclusion: bankers like grey areas in the compliance regime since it occasionally allows them to take risks, with the help of scamsters, to impr-ove their own balance-sheets. They may or may not personally benefit from this corrupt and dangerous practice, but they like the leeway they get to make more easy money on the side by allowing the deployment of their funds in high yielding assets or activities. At some point, greed gets the better of them and they take even bigger risks, and bet the farm on such dubious practices. And they then lose it all.
The moral of the story: bankers like loopholes and grey areas in rules and regulations since it improves their freedom to make more money. Loopholes are not always accidents that happen to the unwary; they may sometimes be deliberately created to facilitate scamsters and their bankers.
(The writer is a editorial director, Swarajya Magazine)