Banking System in India and Nirav Modi Scam

4.4 : Economics -II

Submitted by:
Aniket Taywade
UG16-55
II year, IV semester

Submitted to:
Prof. Sumit Malviya
Assistant Professor, Economics.

Maharashtra National Law University, Nagpur

1
 TABLE OF CONTENTS
INTRODUCTION ..................................................................................................................... 3

BANKING SYSTEM IN INDIA:.............................................................................................. 4

TYPES OF SCHEDULED COMMERCIAL BANKS .......................................................... 5

PUBLIC SECTOR BANKS ................................................................................................... 5

TRANSFER OF MONEY WITHIN THE BANKING STRUCTURE: ................................ 6

NIRAV MODI SCAM ............................................................................................................... 7

THE PRIME REASON BEHIND THE FRAUD. ..................................................................... 9

CRITICAL ANALYSIS .......................................................................................................... 12

WHAT CAN BE DONE TO PREVENT THE FRAUDS? ..................................................... 14

2
 Introduction
The banking system in India Forms the backbone of the entire economic system of India. The
banking activity means accepting of deposits of money from public, for the purpose of lending
or investment. Banks contribute to economic development by mobilizing small and scattered
savings of the community and disbursing those as loans among enterprises. In India, banks
have played an important role in economic growth and development. Since the 1970s, public
sector banks (PSBs) have been in the forefront of mobilizing resources from far flung rural
areas as well as extending banking services in the remotest parts of the country.

In addition to the above traditional roles, banks also perform certain new age functions which
could not be thought of a couple of decades ago. Today, the banking sector is one of the biggest
service sectors in India. Availability of quality services is vital for the well-being of the
economy.
Even though India has a strong Banking system but in the last three years, public sector banks
(PSBs) in India have lost a total of Rs. 22,743 crore,on account of various banking frauds. With
various measures initiated by the RBI, numbers of banking fraud cases have declined, but
amount of money lost has increased in these years.
Prima facie, an initial investigation in these cases has revealed involvement of not only
midlevel employees, but also of the senior most management as was reflected in the case of
Syndicate Bank and Indian Bank moreover in Case of PNB the fraud jolted the entire Banking
mechanism of the India continued for nearly 8 years till it finally came out.

The project deals with the banking system in India and how does it function and the Largest
came in India the NIRAV MODI SCAM and how did the scam occur and what can be done to
overcome the future Frauds in India.

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 Banking System in India:
The Banking system in India in India is not a very complex structure this can be understood
from the discussion below:

The RBI is the supreme monetary and banking authority in the country and controls the banking
system in India. It is called the Reserve Bank’ as it keeps the reserves of all commercial banks.
All the banks in India which are in India come under the purview of the RBI.1

The banks in India are divided into Schedule and non-scheduled Banks.

A scheduled bank is a bank that is listed under the second schedule of the RBI Act, 1934. In
order to be included under this schedule of the RBI Act, banks have to fulfill certain conditions
such as having a paid up capital and reserves of at least 0.5 million and satisfying the Reserve
Bank that its affairs are not being conducted in a manner prejudicial to the interests of its
depositors. Scheduled banks are further classified into commercial and cooperative banks.

Non- scheduled banks are those which are not included in the second schedule of the RBI Act,
1934. At present these are only three such banks in the country.

The Scheduled banks are further divide into Commercial and Cooperative banks. Commercial
Banks Commercial banks may be defined as, any banking organization that deals with the
deposits and loans of business organizations.2 Commercial banks issue bank checks and drafts,
as well as accept money on term deposits. Commercial banks also act as moneylenders, by
way of installment loans and overdrafts. Commercial banks also allow for a variety of deposit
accounts, such as checking, savings, and time deposit. These institutions are run to make a
profit and owned by a group of individuals.

Scheduled Commercial Banks (SCBs):

Scheduled commercial banks (SCBs) account for a major proportion of the business of the
scheduled banks. SCBs in India are categorized into the five groups based on their ownership
and/or their nature of operations. State Bank of India and its six associates (excluding State
Bank of Saurashtra, which has been merged with the SBI with effect from August 13, 2008)

1
https://economictimes.indiatimes.com/industry/banking/finance/banking/everything-you-need-to-know-about-
the-pnb-scam/newslist/62929480.cms accessed on 14-04-2018
2
https://www.businesstoday.in/sectors/banks/pnb-fraud-nirav-modi-public-sector-banks-sbi-privatise-
psu/story/271662.html accessed on 19-04-2018

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are recognised as a separate category of SCBs, because of the distinct statutes (SBI Act, 1955
and SBI Subsidiary Banks Act, 1959) that govern them.

Nationalised banks and SBI and associates together form the public sector banks group IDBI
ltd. has been included in the nationalised banks group since December 2004. Private sector
banks include the old private sector banks and the new generation private sector banks- which
were incorporated according to the revised guidelines issued by the RBI regarding the entry of
private sector banks in 1993.

Foreign banks are present in the country either through complete branch/subsidiary route
presence or through their representative offices.

Types of Scheduled Commercial Banks

Public Sector Banks

These are banks where majority stake is held by the Government of India. Examples of public
sector banks are: SBI, Bank of India, Canara Bank, etc.

Private Sector Banks:

These are banks majority of share capital of the bank is held by private individuals. These
banks are registered as companies with limited liability. Examples of private sector banks are:
ICICI Bank, Axis bank, HDFC, etc.

Foreign Banks:

These banks are registered and have their headquarters in a foreign country but operate their
branches in our country. Examples of foreign banks in India are: HSBC, Citibank, Standard
Chartered Bank, etc

The Banking structure as mentioned above is regulated by the RBI, but the Autonomy of the
functioning of the banks is taken care of every time.

Public Sector Banks

Public sector in the banking industry emerged with the nationalization of Imperial Bank of
India (1921) and creating the State Bank of India (1955) as a part of integrated scheme of rural
credit proposed by the All India Rural Credit Survey Committee (1951).3 The Bank is unique

3
https://www.financialexpress.com/industry/banking-finance/nirav-modi-fraud-effect-pnb-takes-steps-to-
secure-swift-operations/1097468/ accessed on 12-04-2018.

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in several respects and it enjoys a position of pre-eminence as the agent of RBI wherever RBI
has no branches.4 It is the single largest bank in the country with large international presence,
with a network of 48 overseas offices spread over 28 countries covering all the time zones.

One of the objectives of establishing the SBI was to provide extensive banking facilities in
rural areas by opening as a first step 400 branches within a period of 5 years from July 1, 1955.
In 1959, eight banking companies functioning in formerly princely states were acquired by the
SBI, which later came to be known as Associate Banks. The Public sector in the Indian banking
got widened with two rounds of nationalization-first in July 1969 of 14 major private sector
banks each with deposits of Rs. 50 crore or more, and thereafter in April 1980, 6 more banks
with deposits of not less than Rs. 2 Crore each.

It resulted in the creation of public sector banking with a market share of 76.87 per cent in
deposits and 72.92 per cent of assets in the banking industry at the end of March 2003. With
the merger of 'New Bank of India' with 'Punjab National Bank' in 1993, the number of
nationalized banks became 19 and the number of public sector banks 27. The number of
branches of public sector banks, which was 6,669 in June 1969, increased to 41874 by Mach
1990 and again to 46,752 by March 30, 2003. The public sector banks thus came to occupy a
predominant position in the Indian banking scene. It is however, important to note that there
has been a steady decline in the share of PSB's in the total assets of SCB's during the latter -
half of 1990s. While their share was 84.5 per cent at the end of March 1996, it declined to 81.7
per cent in 1998 and further to 81 per cent in 1999.

Transfer of Money within the Banking structure:

A wire transfer is an electronic transfer of money. A traditional wire transfer goes from one
bank or credit union to another using a network such as SWIFT or Fedwire. But the term wire
transfer gets used for other types of transfers as well, so clarify the requirements if somebody
asks for a wire transfer. Those other types of electronic transfers are described at the bottom of
this page. But usually, if somebody asks for a “bank wire,” they want the traditional bank-to-
bank transfer. Otherwise, a money transfer service or another type of electronic payment might
be acceptable.

4
https://www.iimb.ac.in/research/sites/default/files/WP%20No.%20505.pdf accessed on 19-04-2018.

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Speed of Wire Transfers

Wire transfers are useful because the money moves within one or two days. Within the United
States, same-day transfers are possible, and international transfers take an extra day or two.

Cleared funds: Because the money moves quickly, the recipient should not have to wait for
funds to clear before claiming or using the money.

In other words, there is usually no hold placed on money received via wire transfer. For
anybody selling merchandise or services, a wire transfer is safer than a check. Checks can
bounce, and it can take several weeks (or more) to find out that a payment was bad.

Processing time: Wires can be completed in one day, depending on how early you submit your
request to send money.

It may take several hours for the receiving bank to show the wire proceeds in the recipient’s
account—even if the money is at that bank. A bank employee may just need to complete several
tasks to make the funds available.

NIRAV MODI SCAM

Nirav Modi Scam, one of the Largest Scam in India, has jolted the entire banking system and
the economic order in India. The NiMo Scam also Known as PNB Fraud came in public domain
on the 14th February 2018 creating a huge chaos in the entire Indian Economy. 5 The matter
came in limelight when the Bombay Stock Exchange was informed by the PNB that there have
been certain “fraudulent and unauthorised transactions” amounting to Rs 11,400 crore at its
Brady House branch in Mumbai.

The PNB fraud surfaced after one of the key accused bank official retired. Investigation showed
the bank had issued hundreds of unauthorized PNB LoUs to Modi and his uncle, Mehul Choksi
of Gitanjali Gems Ltd, baring the bank fraud that proceeded undetected for the past seven
years.6 CBI found that the bank officials—Gokulnath Shetty, a deputy manager in its foreign
exchange department; and Manoj Kharat, who operated the financial messaging system
SWIFT. Both have since been arrested. PNB, had issued LoUs without getting proper approvals

5
https://economictimes.indiatimes.com/industry/banking/finance/banking/nirav-modi-scam-icai-panel-yet-
to-receive-info-from-punjab-national-bank/articleshow/63734168.cms accessed on
6
https://www.businesstoday.in/sectors/banks/live-updates-rs-11300-crore-fraud-at-pnb-cbi-begins-probe-
nirav-modi-jewellery/story/270707.html accessed on 16-04-2018.

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and without making entries in the core banking system (CBS), the software used to support a
bank’s most common transactions. It is a record keeper.

The Entire scam can be understood by the way of understanding about the Transaction
Technicalities.

Buyers Credit is, typically, a short-term loan facility extended to an importer by a bank to
finance goods and services. It is a common mode of transaction in international trade where a
bank extends credit to the importer and a finance agency based in the exporter's country
guarantees the loan.

On further Inquiry the bank officials discovered that two of its employees had fraudulently
issued LOUs in the past without following prescribed procedures and approvals. The
employees had then transmitted SWIFT7 instructions to the overseas branches of Indian banks
for raising Buyer's Credit without making entries in banking system to avoid detection.

The fraud started probably in 2011-2012 With a very small amount being transferred. The
Misuse of the SWIFT and the Failure to supervise the transaction can be termed prime reasons
for the Fraud being committed.

The Entire scam can be understood by the way of understanding about the Transaction
Technicalities.

Buyers Credit is, typically, a short-term loan facility extended to an importer by a bank to
finance goods and services. It is a common mode of transaction in international trade where a
bank extends credit to the importer and a finance agency based in the exporter's country
guarantees the loan.

On further Inquiry the bank officials discovered that two of its employees had fraudulently
issued LOUs in the past without following prescribed procedures and approvals. The
employees had then transmitted SWIFT instructions to the overseas branches of Indian banks
for raising Buyer's Credit without making entries in banking system to avoid detection.

The fraud Started Probably in 2011-2012 With a very small amount being transferred.The
Misuse of the SWIFT and the Failure to Supervise the transaction can be termed prime reasons
for the Fraud being committed.

7
https://www.investopedia.com/articles/personal-finance/050515/how-swift-system-works.asp accessed on
14-04-2018.

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 THE PRIME REASON BEHIND THE FRAUD.
SWIFT stands for the Society for Worldwide Interbank Financial Telecommunication. SWIFT,
is a system to send instant messages. Once a foreign bank or a foreign branch of a bank gets
the LoU via the SWIFT message, it disburses the loan to the borrower. SWIFT assigns each
financial organization a unique code that has either eight characters or 11 characters. The code
is called interchangeably the bank identifier code (BIC), SWIFT code, SWIFT ID, or ISO 9362
code. The majority of SWIFT clients have huge transactional volumes for which manual entry
of instructions is not practical.

The need for automation for SWIFT message creation, processing, and transmission is
growing. However, this comes at a cost and operational overhead. Although SWIFT has been
successful in providing software for the same, that too comes at a cost.8 SWIFT may need to
tap into these problem areas for the majority of its client base. Automated solutions within this
space may bring in new stream of income for SWIFT and keep clients engaged in the long run.

Letter of undertaking: It is a guarantee that a bank is obliged to repay the loan if the actual
borrower—Nirav Modi in this case—fails. An LoU is Anassurance given by one bank to
another to meet a liability on behalf of a customer (NiravModi).The LoU is a kin to letter of
credit or a guarantee.

When the credit due was not paid in time, more LoUs were issued on behalf of PNB to offset
the payment.

What is “offsetting the payment”?

When the borrower did not repay the first Rs800 crore, the bank ought to have stepped in and
booked a default by the group company. Instead, the two PNB employees, who were allegedly
party to the fraud, issued more LoUs on behalf of PNB, asking other banks to give out fresh
loans to the firms. This continued until two weeks before the whole operation came to light
after some of Modi’s employees visited the bank on Jan. 05. The management was caught
napping and the overdue loans exceeded Rs11,000 crore.

8
https://scroll.in/article/869394/understanding-swift-the-messaging-system-at-the-heart-of-the-1-8-billion-
pnb-fraud accessed on 19-02-2018.

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CBS:

It is a centralised software that keeps all records across branches and is capable of generating
alerts over any undue activity.

The age of modern banking goes back to late eighteenth century. Bank of Hindustan was one
of the first to be established in the year 1770. It was the State Bank of India, which laid the
foundation of modern banking in India post-independence in 1955. SBI was the amalgamation
of 3 banks funded by the pre independence presidency government, namely Bank of Bengal,
Bank of Madras and Bank of Bombay. As for the central banking authority (or may be referred
as statutory body), for long Presidency Banks acted in this position, till in 1935 Reserve Bank
Of India (RBI), took over the position, after the 1934 Reserve bank of India act was passed.

Although RBI was formed in April 1935, it was nationalised only in January 1949 under the
terms of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948. Also in 1949,
banking regulation act was enacted to give RBI power to regulate, control and inspect all Indian
Banks. The two other major event worth a note in the history of modern year of banking are the
nationalisation of 14 largest commercial banks in 1969, through banking companies bill. Later
another set of 4 banks were merged, taking the count to 20. At this point more than 90% of all
banking business in India was controlled by Govt. of India. Later in the 1990’s, post
government liberalisation policies, a host of private players got an entry into India banking
scenario under strict guidelines of RBI, with a regular scrutiny of ensuring the guidelines are
met and any irregularities may lead to the disqualification of their licences.

As per Section 5(c) of the Banking Regulation Act, 1949 a "Banking Company" means any
company which transacts the business of banking in India.

Explanation: Any company which is engaged in the manufacture of goods or carries on any
trade and which accepts the deposits of money from public merely for the purpose of financing
its business as such manufacturer or trader shall not be deemed to transact the business of
banking within the meaning of this clause."

As per Section 5(b) of the Banking Regulation Act, 1949 , "banking" means the accepting, for
the purpose of lending or investment, of deposits of money from the public, repayable on
demand or otherwise, and withdrawable by cheque, draft, order or otherwise.

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As per Section 5(d) of the Banking Regulation Act, 1949 , "company" means any company as
defined in Section 3 of the Companies Act, 1956 and includes a foreign company within the
meaning of Section 591 of that Act.

As per section 51 of the Banking Regulation Act, 1949 , certain provisions of the Banking
Regulation Act are also applicable to the State Bank of India , any corresponding new bank, a
regional rural bank and any subsidiary bank. "Corresponding new bank" has been defined under
clause(e) of section 2 of the DICGC Act to mean a corresponding new bank constituted under
the Banking Companies (Acquisition and Transfer of Undertakings ) Acts of 1970 or 1980.

Fraud is any dishonest act and behaviour by which one person gains or intends to gain
advantage over another person. Fraud causes loss to the victim directly or indirectly. Fraud has
not been described or discussed clearly in The Indian Penal Code but sections dealing with
cheating. concealment, forgery counterfeiting and breach of trust has been discusses which
leads to the act of fraud.In Contractual term as described in the Indian Contract Act, Sec 17
suggests that a fraud means and includes any of the acts by a party to a contract or with his
connivance or by his agents with the intention to deceive another party or his agent or to induce
him to enter in to a contract.

Banking Frauds constitute a considerable percentage of white-collar offences being probed by

the police. Unlike ordinary thefts and robberies, the amount misappropriated in these crimes
runs into lakhs and crores of rupees. Bank fraud is a federal crime in many countries, defined
as planning to obtain property or money from any federally insured financial institution. It is
sometimes considered a white collar crime.

The number of bank frauds in India is substantial. It in increasing with the passage of time. All
the major operational areas in banking represent a good opportunity for fraudsters with growing
incidence being reported under deposit, loan and inter-branch accounting transactions,
including remittances.

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 Critical Analysis

As recent data on non-performing assets (NPAs) show, the PSBs have also made bad loans
galore, all of which are coming home to roost now. The three major scams that have made
headlines in the past month have also largely involved public sector banks - the Nirav Modi-
Mehul Choksi case (Punjab National Bank), the Rotomac case (Bank of Baroda) and the
Sambholi Sugars case (Oriental Bank of Commerce) - though some private sector banks had
also given smaller loans.The government is the majority owner of 21 banks currently and in
the year 2016-17, nine of them reported losses. The previous year (2015-16) 13 PSBs had
reported losses. In the current fiscal, the number of PSBs reporting losses might be even more,
as they make provisions for the scams that have come to light and also for the NPAs that are
now being referred to the National Companies Law Tribunal (NCLT) under the Insolvency and
Bankruptcy Code (IBC) for resolution.

By the second quarter of this fiscal (2017-18), the bad loans of the PSBs had reached Rs 7.34
lakh crore (compared with the Rs 1.03 lakh crore of the private sector banks). And as the recent
cases show, many PSBs do not have the risk management systems to spot frauds early enough,
if there is a rogue employee, or a group of them, involved.

This government, of course, doesn't want to privatise the PSBs - in fact it plans to merge several
of them to have half a dozen large banks instead of 21 banks of all sizes. The stated goal of the
Modi government is to finally have four or at most five very big PSB banks by merging them.
That might make sense in terms of having banks with big balance sheets, but it will not do
anything much for the asset qualities of these banks. Merging three banks with bad loan books
will only get you one big bank with a very large and bad loan book.

There have been multiple suggestions that the government should own only the biggest PSB -
the State Bank of India (SBI) - and that should be enough. SBI's balance sheet size of Rs 27.6
lakh crore is bigger than the balance sheet of the next two banks (HDFC Bank and ICICI Bank)
put together. After the merger with its associate banks, it is now among the top 50 banks in the
world in terms of size. And in terms of banking depth and branch spread, it is more than capable
of executing all the programmes that the government announces for the poor and the farmers
from time to time.

The rest of the PSBs make a motley lot. They range from PNB (which is currently in the eye
of the scam so to say and is the fourth largest bank in India in terms of balance sheet size) to
Punjab & Sind Bank, which is among the smallest banks in terms of balance sheet size (Rs

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96,643 crore).Privatising all the others apart from SBI would make economic sense for a
government because it would not have to worry about NPAs, frauds or recapitalizing the banks.
It would be good for the banks because they would be freed from political pressures and will
be able to take decisions based on business risk assessment and opportunities. It is true that
even private banks can see frauds and come to the brink of collapse (the Nick Leeson-Barings
Bank case or the Lehman Brothers case are recent global examples) and from time to time even
Indian private banks have come close to collapsing (Global Trust Bank and the Lord Krishna
Bank are two relatively recent cases). But in both cases, they merged with stronger banks, with
some encouragement from the RBI.

It is also true that a couple of private sector banks currently have seen a sharp rise in their gross
NPAs, and they have also been pulled up by the RBI for the divergence between their estimates
of their NPAs and the central bank's estimates. Having said that, in general, the current private
sector banks are, in general, run better than most of their public sector counterparts. Some of
the ideas being considered include having a separate pre-sanction appraisal and post sanction
monitoring teams for credit disbursal to ensure better governance and transparency, official
sources said.

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 What can be done to prevent the Frauds?

A new monitoring group should be set up to keep track of whether cash flow from projects is
being used to repay bank loans and that there are no slippages, sources said, adding that a
separate vertical to be created for stressed asset recovery.

We should stop pretending that everything is fine. Ever-greening of loans should be stopped
forthwith. An honest assessment should be made of the entire situation to understand the full
extent of the problem.

2) Defaulters should be divided into three categories. In the first category we should place those
defaulters who have been compelled to default for none of their fault. This will include
promoters whose projects are stalled because they did not get clearances from the government
like forest and environment clearances or land was not acquired in time or infrastructure
facilities like rail, road or electricity connection were not provided to them.

These defaulters should be rendered all help so that their projects get going and the NPAs are
liquidated. In the second category we should place such defaulters who managed to secure bank
loans undeservedly. Either their projects were not appraised properly or they did not have the
necessary entrepreneurial or management ability or skill to bring the project to fruition. The
solution in such cases is to separate the project from its promoter and, through a transparent
process, hand over the project to another promoter for completion or operation.

The third category consists of willful defaulters. Such defaulters are criminals and should face
the full force of law. They deserve no consideration whatsoever. According to official
estimates, more than 1 lakh crore is involved in such defaulting. My own guess is that the
amount is much larger than the figure mentioned above. It is also important that such defaulters
are not allowed to flee the country.

3) The asset reconstruction companies should be further straightened so that banks can transfer
to them the more difficult NPAs and concentrate on their core business.

4) An independent body of experts should be appointment to study the appraisal system of the
banks so that projects are properly assessed before loans are advanced to the promoters.

14
 BIBLIOGRAPHY:
1.https://economictimes.indiatimes.com/industry/banking/finance/banking/everything-you-
need-to-know-about-the-pnb-scam/newslist/62929480.cms accessed on 14-04-2018
2.https://www.businesstoday.in/sectors/banks/pnb-fraud-nirav-modi-public-sector-banks-sbi-
privatise-psu/story/271662.html accessed on 19-04-2018
3.https://www.financialexpress.com/industry/banking-finance/nirav-modi-fraud-effect-pnb-
takes-steps-to-secure-swift-operations/1097468/ accessed on 12-04-2018.
4.https://www.iimb.ac.in/research/sites/default/files/WP%20No.%20505.pdf accessed on 19-
04-2018.
5.https://economictimes.indiatimes.com/industry/banking/finance/banking/nirav-modi-scam-
icai-panel-yet-to-receive-info-from-punjab-national-bank/articleshow/63734168.cms
6.https://www.businesstoday.in/sectors/banks/live-updates-rs-11300-crore-fraud-at-pnb-cbi-
begins-probe-nirav-modi-jewellery/story/270707.html accessed on 16-04-2018.
7.https://www.investopedia.com/articles/personal-finance/050515/how-swift-system-
works.asp accessed on 14-04-2018.
8.https://scroll.in/article/869394/understanding-swift-the-messaging-system-at-the-heart-of-
the-1-8-billion-pnb-fraud

9.https://timesofindia.indiatimes.com/business/india-business/pnb-scam-is-worth-3-days-of-
indian-banking-systems-interest-bse-ceo/articleshow/63678513.cms

10.https://www.livemint.com/Opinion/ep5zwxjy8OlyrB9HOljmdO/Why-banking-frauds-are-
so-frequent-at-PSU-banks.html

11.https://www.livemint.com/Sundayapp/fjheowjLjiFNsGcjzVZXsO/Banking-crises-An-
Indian-history.html

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