Nirav Modi Scam Explained

    1. What is the fraud about?

Two PNB employees sent unauthorised letters of undertaking (LOU), essentially Bank Guarantees to foreign branches of Indian lenders, on behalf of firms related to Nirav Modi and Gitanjali Group so that they can pay for their imports, if they don’t pay up, we will make good this payment.

   2. What’s irregular about this?

 In the normal course, when an importer goes to bank for such a guarantee, one of two things happen. Bank ask for a collateral before it gives guarantee, the collateral should be property in his name or a fixed deposit with bank. Second, bank sanctions the credit limit.

In PNB fraud case, bank has given guarantee without credit limit and collateral security. Secondly, they didn't make entry in the bank’s core banking system – the software used to support a bank’s most common transactions.

   3. Why would an importer use this method to raise money?  

There are multiple reasons. For one, he has to raise money in foreign currency to pay for goods bought abroad. Second, the cost of such foreign currency borrowings abroad is typically lower.

  

  4. What happens when the foreign bank or branch receives this    guarantee? 

     When foreign bank or branch receive guarantee, it will give a loan to the importer. That means it will deposit money either in the accounts of the supplier who’s selling goods to the importer, or in PNB’s account held with it. The tenure of this loan varies from 90 days to 5 years for capital goods.

The money used to settle the payment for imports. Then, when the term of the loan is up and the importer makes money from reselling the goods he imported, he will pay this sum to bank with interest. Bank in turn will settle with other banks.

In this case, money raised through this guarantees was not used to make payments for imports. But it was used to settle earlier loans taken. Every time, a Nirav Modi related firm ask for a bank guarantee, it was to settle an older loan taken through a previous bank guarantee. Thus amount piled upto around Rs 11,400 crore.

  5. How was this detected?

According to FIR, two junior employees of PNB had been sending these unauthorised guarantees for 7 years. Then, one of them retired. In January, when representatives of Modi firms asked for a fresh guarantee, the new PNB employee in that position asked for collateral security. On being told that this was never been asked in the past, the bank start investigating and found hundreds of guarantees relating to these firms.