Rot in PSBs Part 2: PNB, Nirav Modi, Vikram Kothari aren’t the first; India’s PSBs have long been beaten by frauds

The Rs 11,400-crore bank fraud in Punjab National Bank, that was perpetrated by billionaire Nirav Modi in collusion with a few bank employees, has once again brought governance practices in Public Sector Banks (PSBs) back to public debate. There are questions raised on the way these entries function. A political blame game is on. But the problems in this sector are far beyond one instance of fraud. After five decades of bank nationalisation, India's public sector banks face deeper structural problems ranging from poor management practices, ineffective risk-management  systems, vulnerability to a political-corporate nexus, large chunk of bad loans and lack of sufficient autonomy. Firstpost will publish a multi-part series that examines the serious structural problems that have engulfed India's state-run banks and the likely course of this industry, which constitutes 70 percent of India's banking sector assets. 

Warning bells ring

On 24 November, 2010, at around noon, the Central Bureau of Investigation (CBI) called a press conference in Mumbai to make an important announcement. As the media waited eagerly for the finer details, the central agency announced the arrest of eight bank officials including the then chief executive officer (CEO) of LIC Housing Finance Ltd in Mumbai, a top officer of LIC and officials of Bank of India (BoI), Central Bank of India and Punjab National Bank (PNB). During the course of the presser, the CBI claimed to have broken the back of a corporate loan racket, wherein bank officials allegedly took bribe from middlemen on behalf of companies to arrange loans to them that wouldn’t be given under normal course of credit operations.

As the details of the 'corporate loan scam' or 'bribe-for-loan scam' (as media the called it) unveiled, the then Union finance minister Pranab Mukherjee warned banks then to take action against the bankers involved in the scam and put proper checks and balances to avoid the recurrence of such frauds. It is another thing entirely that the CBI could never follow up with a strong case in the court of law. But the big takeaway is that bankers never learned their lesson.

It's all about middlemen

The instances of fraudulent transactions and loan scams involving bank officials continued. This included both and big and small frauds — Citibank fraud, Bank of Baroda forex scam, Syndicate Bank fraud and several other lesser-known scams. In most instances, the victims were public sector banks and culprits their own officials. Most cash-for-loan scams happened through middlemen. "There are many advisory firms that arrange loans for companies from banks, offering bank officials kickbacks. Big firms don’t need them but mid-sized and small companies go after these middlemen to approach bankers," said a senior banker with experience of over 30 years, who didn’t wish to be named.

"The bribe for the banker may not be in the form of cash but other favours that aren't easy to detect in the event of an investigation," he continued. There were instances of bankers getting caught accepting even not-so-expensive watches or gold ornaments. "Some do it for money, some for relations and some for even flattery. If you think about it, it is so strange that sometimes the reasons for people falling for illegal activities are trivial," he added. Some bankers cite the relatively low wages offered by state-run banks to their officers in comparison with private and foreign counterparts as a motivating factor to commit fraud and take bribes.

Checks in place, but no one cares

Looking at PNB-like frauds, if someone thinks that there are no checks in place in the system, they are wrong. "There are checks but no one really cares," said another banker who too requested anonymity. He takes the example of the LoU (Letters of Undertakings) fraud in PNB. If a branch-level official does a transaction of this manner for a period of seven years, it can get caught at different levels if any of the checks in place triggered this illegal activity.

For instance, the SWIFT messaging platform that was used by the perpetrators in the PNB case is subjected to a daily check by the branch manager, which is compulsory in any bank. Even if one imagines that this part failed, the branch manager has to do a daily tally of income and expenditure in the branch while one of the officers (not involved in the transactions) combs through the books to look for suspicious transactions, the official said. "Besides these daily checks, the bank does concurrent audit which happens concurrently throughout the year. Such fraud should have reflected there," the official said. This apart, there are RBI and government representatives on the boards of large banks who are supposed to keep an eye on all transactions and ensure that nothing goes amiss.

"But, it appears that all of them were sleeping when a fraud was developing," said the second banker. That apart, given the tremendous pressure on bankers to generate business, top-level officers often turn a blind eye to illegal business activities.

The art of acting too late

It's not just about fraud, but also about wrong credit decisions and the art of acting too late. Banks continued to support Kingfisher despite fully knowing that things were not looking good financially. Lenders offered to restructure Vijay Mallya's loan after realising that they had already thrown good money after bad. In March 2012, Kingfisher halted its international operations to Europe and Asian countries and cut down local flights to 110 to 125 a day with a fleet of 20 planes (down from from 340 flights earlier) to save money. By October 2012, the bird flapped its wings for the last time. Since then, it hasn’t seen the skies.

Kingfisher, once the second-largest airline in India, had little chances of resuming its operations since the necessary regulatory approvals were not in sight and its balance sheet was bleeding. The company's losses had expanded to Rs 2,142 crore for its fiscal fourth quarter ending in March 2013, compared with a net loss of Rs 1,150 crore a year earlier. The accumulated losses as of March 2013 stood at a whopping Rs 16,023 crore.