How the alleged Punjab National Bank fraud unfolded

Two years ago, Indian industrialists, Bollywood stars, fashion designers and erstwhile royalty gathered at Rajasthan’s elegant Umaid Bhawan palace for the fifth anniversary of India’s first western-style luxury jewellery brand, owned by Nirav Modi. 

Models wearing gowns of fresh flowers and the host’s glittering diamond jewellery mingled with guests on the palace lawns as Mr Modi presented himself as India’s answer to Cartier. 

But the once high-flying jeweller has now gone to ground. He and his uncle, diamond dealer Mehul Choksi, are sought by Indian authorities, which say the pair and their companies were among the beneficiaries of an alleged $1.77bn bank fraud that has shaken confidence in India’s state-dominated banking system. 

The alleged fraud took place in the state-owned Punjab National Bank’s far-from-glamorous Brady House branch, located in a fusty colonial-era building in Mumbai’s historic business district. 

There, Gokulnath Shetty, a deputy branch manager, and his subordinate, allegedly provided unapproved, “fraudulently issued” bank guarantees to Mr Modi’s firms, and Mr Choksi’s Gitanjali Gems, one of India’s largest mass market jewellery retailers, according to a complaint by PNB to the Central Bureau of Investigation.

These fake guarantees enabled the jewellers to receive overseas cash advances — supposedly for trade finance — from other Indian lenders, all ostensibly backed by PNB. But India’s second-largest state bank had no central record of the obligations mounting in its name — as rogue employees exploited the lender’s outdated software to make international transactions without attracting headquarters’ attention, bank officials say. 

Diamond dealer Mehul Choksi, pictured with two Bollywood actresses at a Mumbai racecourse, is being sought by Indian authorities for his role in the alleged fraud © AFP

The discovery of the fraud has re-ignited concerns about operations and oversight at India’s stressed state lenders, now undergoing a $32bn recapitalisation intended to clean up their balance sheets after a wave of corporate defaults

India’s diamond jewellery companies were already considered risky bets, given the trade’s traditional association with money-laundering and a string of defaults and bankruptcies in the sector. 

“Something like this, in a sector that is so vulnerable, should have been flagged automatically,” says Reshmi Khurana, head of south Asia for risk consultancy Kroll. “It shouldn’t even require human intervention.” 

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So far, India’s Central Bureau of Investigation has arrested five jewellery firm executives — including Vipul Ambani, chief financial officer of Mr Modi’s firm, Firestar Diamonds, and six PNB employees. 

Centre of the alleged fraud: the PNB Brady House branch in Mumbai © AP

Part of an Antwerp-based, Indian diamond-trading family, Mr Modi launched his eponymous brand in 2010 and quickly developed a reputation for lavish designs, artful craftsmanship and eye-popping prices. 

Vijay Agarwal, a lawyer for Mr Modi, has denied any wrongdoing by his client, telling journalists the accusations would fall apart under close scrutiny. 

Providing trade finance guarantees is big business for Indian lenders — a lucrative fee-based service that does not require the lenders to provide cash upfront to their clients. But analysts say they have long feared the system is vulnerable to abuse. 

According to preliminary complaints filed to the CBI, and published on the CBI website, the fraudulent guarantees — called letters of credit or letters of undertaking — were issued for the jewellery companies “without following the proscribed procedures,” such as obtaining import documents, or necessary approvals. 

These guarantees were then sent via Swift messages to overseas branches of Indian lenders — including State Bank of India, Axis Bank, Allahabad Bank and Canara Bank — which then made local currency payments to designated bank accounts in Antwerp, Frankfurt, Hong Kong, Mauritius and Bahrain. 

However, PNB employees failed to record these guarantees in the lender’s central information system, thus “avoiding detection,” says one CBI complaint. In other cases, letters of credit to Gitanjali firms were entered into PNB’s core banking system — but only at a fraction of their face value, a second CBI complaint says. 

These omissions were enabled by PNB’s own failure to keep pace with fast-developing financial technology, a senior PNB official, who asked not to be identified due to the sensitivity of the matter, told the FT this week.

PNB has relied on Finacle — developed by IT giant Infosys — as the key IT “backbone” of its operations since 2001. But PNB’s outdated version of the software was not integrated with Swift, the international financial messaging system. That meant Swift transactions had to be logged separately into PNB’s core banking system, the PNB official said.

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While Infosys’ 2008 version of Finacle integrated the two systems, PNB did not upgrade to the new software, allowing certain members of Brady House branch staff to continue sending Swift requests without detection. Infosys declined to comment on the alleged fraud.

The PNB official told the FT that suspicious transactions began in 2011, although the bank has given no public account or details of these deals. During the first five months of 2017, PNB’s Brady House branch provided Gitanjali group companies with guarantees for $473m through 140 letters of understanding to seven different banks, according to the bank’s complaint to the CBI. 

It also issued another 200 foreign letters of credit worth $359m in that period — all unrecorded, or under-recorded in its main system, the lender says. 

On May 31, Mr Shetty, the deputy branch manager who had facilitated the guarantees, retired from PNB, having worked at the Brady House branch for nearly seven years despite risk management procedure stating that staff should rotate regularly. 

PNB says it discovered the fraudulent guarantees — some apparently used to pay off older loans coming due — on January 16, when a representative of Mr Modi’s firm sought a new letter of undertaking to support further overseas borrowing. 

“They wanted the process to continue,” the PNB official told the FT. “But the old employees were not there, and the new ones said no to these practices.” 

Protesters in New Delhi hold up a cut-out image of Nirav Modi last week as outrage mounts over the billionaire jeweller and the state-run PNB’s alleged involvement in his enrichment © Reuters

Scrutinising its records — including old Swift messages — the bank uncovered the full scale of the problem, leading to last week’s stunning stock exchange announcement. But Mr Modi, Mr Choksi and their families had already left India in early January — just days before the first of Mr Choksi’s many letters of understanding from last year came due. 

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As the outcry over the alleged fraud mounted, Arun Jaitley, the finance minister, vowed to bring those responsible to account. “It is incumbent on us as a state to really chase these people to the last possible conclusion to make sure that the country is not cheated,” he said.

Authorities have seized diamonds, precious stones, gold and jewellery from the jewellers’ showrooms and offices, frozen bank accounts, and taken steps to revoke Mr Modi’s and Mr Choksi’s Indian passports. 

Meanwhile, India’s state-banks are gearing up for a potentially nasty battle over who will take the financial hit. 

While PNB has promised to take responsibility for all its “bona fide” obligations, the lender has also complained that “officials of overseas branches of Indian banks” failed to undertake “ordinary due diligence” that would have turned up the improprieties. 

“Other banks have . . . not discharged their responsibility,” the PNB official says. 

PNB and CBI declined to comment beyond their public statements.

But analysts warn if PNB tries to push too hard to share financial pain with other banks, it could undermine India’s trade finance system — which depends on mutual trust among different Indian banks. 

“PNB has given a guarantee under its name and this is a routine part of the banking system,” says Alka Anbarasu, an analyst at Moody’s. “It could put the credibility of the banking system at stake.”

Additional reporting by Jyotsna Singh and Andrea Rodrigues