PNB Fraud and the Issue of Bad Loans: The Big Picture

The reported Rs 11,000-plus crore fraud involving the Punjab National Bank, or PNB, reveals a bigger picture and connects with a larger issue. In our article “Bad Loans: How One Government Created a Mess and Another Is Cleaning It Up”, published earlier this week, we had explored the issue of bad loans and non-performing assets (NPAs) in detail and noted how roughly between 2008 and 2014, public sector banks (PSBs) had to indiscriminately issue loans to industrialists, evidently not without compulsion or hints of it, and how when these loans were not repaid, no action was taken by the then government.

In other words, the last government created the mess that came to be known as Indian banking’s bad loans and NPA crisis (the so-called PSB crisis) and the successor government – the current one – had to take action to clean up the same mess. The PNB fraud case, involving jeweller Nirav Modi, actually illustrates the problem and we should study it to understand what had gone on in PSBs and to grasp the significance of what is being done to redress the problem in systemic and structural terms.

The PNB fraud itself dates back to 2011, to the time of the last administration, when Manmohan Singh was Prime Minister. But it was under the watch of the current administration that the fraud was detected – last month, January 2018 – and the investigation begun immediately. Below is a social media report by a news outlet of the statement from the PSB:


Now, while sections of the media and political class have attempted to turn the timeline of bad loans, and thus the narrative, on its head to target the current administration, we must keep that timeline in mind. Even as the news broke on Wednesday February 14, 2018, articles began appearing both in India and abroad talking about a so-called banking crisis in India, critical of the government in office today, and painting bleak scenarios for the future. One such article would be the following, published in Bloomberg: $1.8 Billion Fraud May Spread From One of India’s Biggest Banks.

Since it is quite likely that those responsible for the larger bad loans & NPAs situation, as well as the larger PSB problem, in the first place would be trying to make capital of it, it would serve the cause of truth well to recall the facts of the case and also analyse the bigger picture. To get to that truth, we have to understand how the PNB case, while big in itself and certainly not a one-off occurrence, is part of the larger mess created under the watch of the last government. Again, the efforts of the present government to clean it up and ensure things do not come to such a pass in the future become stark in comparison.


PNB has not stated an estimate for the total amount of the fraud. The CMD of the PSB has stated that PNB is yet to arrive at the total value of the liability, if any. But the media has gone ahead and reported the figure of about Rs 11,400 crore for the fraud, in one of PNB’s Mumbai branches, by jeweller Nirav Modi, among others. Back in 2011, some PNB employees issued fake letters of undertaking (LoUs) for firms owned by Mr Modi and his family. LoUs work like bank guarantees, against which overseas branches of other banks provide credit through networks like SWIFT, on which the issuer bank (PNB) is supposed to pay the principal and interest. Gokulnath Shetty, a deputy manager at PNB, allegedly used his access to the SWIFT network to authenticate guarantees given on LoUs. Basically, the LoUs helped Mr Modi’s companies raise credit.


The reported PNB fraud shows an entrenched problem with PSBs where several Indian banks ended up at the receiving end from both debtors as well as the then government. One such issue is that of bad loans and NPAs, which is the single-biggest aspect of the problem with PSBs. Now, for commentators who might ask how the bad loans problem was created, PNB is a perfect example of how the system was bypassed and defrauded, or how there was a lack of a proper system of checks, when such big monetary transactions were involved. Whether some individuals were involved behind such corruption – as is reportedly the case with PNB – or the issue is larger structural flaws, the fact is that the PNB case is illustrative of how PSBs and, by extension, the economy were jeopardised by policies and practices they were subjected to.

It is perhaps not surprising that something as big as this has surfaced. But to return to the question of bad loans and how they throw light on the practices under the last administration, let us recall that between 2008 and 2014, PSBs disbursed disproportionate sums of loans to several industries. The following graph from the Ministry of Finance paints a clear picture of the situation:

When the debtors delayed the repayment of these loans, there was no action taken by the then government (2008-14). Therefore, there could have been a contribution of the then administration, unwittingly or otherwise, to the creation of the problem of NPAs that its successor inherited.


Asset Quality Review:

As early as 2015, the current government had recognised and classified the problem of NPAs after the Asset Quality Review (AQR). The recognition of the correct amount of NPAs in PSBs had raised the NPA amount from Rs 2.78 lakh crore in March 2015 to Rs 7.33 lakh crore by June 2017.

Bankruptcy Code:

The current administration also brought in the Insolvency and Bankruptcy Code, which was enacted into law in May 2016. The Code set up the Insolvency and Bankruptcy Board of India (IBBI) as the regulator on October 1, 2017.

PSB Recapitalisation:

On October 24, 2017, a complete PSB recapitalisation plan of Rs 2.11 lakh crore over the next two years was announced, with recapitalisation bonds as a major component (64%) of the capital infusion plan. The bank recapitalisation process was formally begun, with the announcement of a capital infusion plan of Rs 88,000 crore on January 24, 2018.

FRDI Bill:

The draft FRDI Bill is another proactive step, where a Resolution Corporation (RC) has been proposed, which will identify early warning signs of distress at financial institutions. This body will classify financial firms based on their risk factors as low, moderate, material, imminent and critical. It will protect financial institutions from going bankrupt in future, and provide a framework for redress, if it happens. Till date, no such system exists in India.

Enforcement Directorate:

As far as the PNB case is concerned, the Enforcement Directorate (ED) has been carrying out raids at 13 places across the diamond corridor of Mumbai, Surat and Delhi to comprehend the damage and collect evidence in the Rs 11,400 crore fraud.


It is perhaps important to dwell on the FRDI Bill for a bit longer. A false narrative had been created about the FRDI Bill by sections of the media and the political opponents of the administration that the FRDI Bill would deprive commoners of their money while industrialists and corporates would run away with fat pockets. This argument was pushed especially with reference to the so-called bail-in clause in Section 52 of the Bill and the claim made was that if this Bill became law in the existing format, depositors’ money would be used to bail out failing financial institutions. Concerns were also raised about depositors’ insurance.

The detailed rebuttals to these claims are available in our earlier articles “Busting Persistent Myths About FRDI Bill: Facts About Bail-In Clause and the Bill’s Aims” and “FRDI Bill and Bail-In: Media Puts Too Much Emphasis on Certain Clauses, Too Little on Others”. In brief, commentators and critics had confused “bail-in” and “bail-out”. In the latter, one is looking at money being put into the coffers of an entity while, in the case of the former, one is looking at a restructuring. Section 52, Clause 7 of the Bill clearly states that the bail-in will not come into effect in case of deposits covered by deposit insurance or through holding client assets.

Again, Clauses 8 & 9 clearly state that in case the Resolution Corporation makes a bail-in instrument, it must forward it, with a report, to the Central Government and that the same shall be laid before each House of Parliament. This is meant to ensure that any bail-in process passes through proper checks and balances. Such criticism has also been mistakenly too focused on the existing provision of the depositor’s insurance of Rs 1 lakh that may be taken away. Hypothetically, if somebody has a bank balance of Rs 10 or Rs 20 lakh, or more, the guarantee of Rs 1 lakh would actually be too little.

Since it is every bit possible that sections of the commentariat would again push the argument that the FRDI Bill would only help fraudsters and victimise the public, we must be clear about the fact — the FRDI Bill, as is its purpose, is not going to enable fraud a la PNB but, as it is designed, protect depositors and issue warnings to them well in advance if the health of a financial institution happens to be in doubt. Thus, banks would actually fare better and depositors get more protection with the FRDI Bill in place.