Disclaimer: This PNB Scam Story is still developing, and all the facts are not in place. We will keep updating the readers as and when the facts are rolled out.
To understand what exactly happened, how it happened and what will happen now, it is crucial to understand why banks are critical for trade. Banking is basically about trade finance and cash management. It is no surprise that most of banks are based out in cities that are major points on the global trade routes – Sydney, Hong Kong, Tokyo, Singapore, Mumbai, London, and New York.
So why are banks required for trade? The simple answer to it is lack of trust between counter parties – people don’t trust each other while trading but both of them trust the banks, and this trust is the basis of all the transactions that we see around us.
To think of this, imagine there are two counterparties – Bill Gates and Jeff Bezos. Jeff Bezos is importing equipment from Bill Gates. However, both don’t trust each other – what is the surety that Bezos will pay Gates when he receives the goods and what is the certainty that Gates will send non-defective goods to Bezos? This is where banks come into play. Both parties trust the bank and hence the bank comes into the picture to settle the trade.
So, Bezos will go to his bank – ECom Bank and put in a deposit of 90-100% to get a letter of credit in favor of Gates’s bank (Software Bank). The Letter of Credit will act as a guarantee that Gates will receive money after delivering the goods even if Bezos defaults on the payment.
PNB Scam:
PNB Scam case is about Letter of Undertaking (LoU). Using the above example, Bezos will go to his bank with 100% cash security of say 100 crores and ask for a LoU to be issued in favor of Gates via his Software Bank. ECom Bank will issue the LoU to Software Bank and then Gates will have a choice to get these 100 crores either as a loan or an overdraft or use it to issue another LC. In case Gates defaults on these loans, Software Bank will be compensated by ECom Bank and Bezos’s cash security will be taken over.
Basically, LoUs are contingent liabilities for ECom Bank – it becomes a real liability only when Gates defaults. It is for this reason, LoU reporting is critical as the exposure can get out of hands very quickly.
In case of PNB Scam, few officials colluded to create fake LoU on PNB’s name and got them authorized and transmitted to other banks via SWIFT network while skipping the CBS network of the PNB. Since the LoU never hit the CBS, they were not reported and hence PNB had no idea about the liabilities that were being taken on its name. The LoUs were for valid for 1yrs and when they were up for renewal, all hell broke loose. Suddenly a scam of 11,300 crore was found.
Now the big question – Is Modi government responsible for the PNB Scam?
Simple answer – NO. It was an operational risk for a bank and PNB failed. There doesn’t seem to be any force which the Modi government applied for this scam.
All the opposition has got is a group pic (of around 25 people) which has both PM Narendra Modi and Nirav Modi. Sometimes, you got to feel sad for the opposition!
PNB Scam: What next – what will happen to all the liabilities hanging in the air?
PNB issued a letter to all the Indian banks stating that it will service the liabilities it owes. However, the fake LoUs are not the liabilities it owes. So, will PNB default on these fake LoU?
If PNB does default on its LoUs, we are looking at a massive banking crisis in the country. All the banks will run helter-skelter to settle their trade products and the economy will come to a standstill. It will be a perfect worst-case scenario!
So, expect PNB to take the hit on its chin and service all the LoUs.
PNB Scam: Indian Banking – Reputation in tatters?
This is not something Indian banks will be able to sweep under the carpet. All banks must be burning the mid-night oil to check their existing open trade documents to filter out the fake ones. This exercise is expected to continue for few weeks before we will get to know the full impact of this scam.
In future, LCs and LoU issued by Indian banks will be looked more closely and few banks may not even accept these products from Indian banks. Unfortunately, the loss will be of Indian banks and Indian importers/exporters.
PNB Scam: Is the situation really bad? Should I withdraw my money from the bank? Should I sell my Mutual Funds?
From what we know till now, the situation is not that bad for the country or the economy. Relax and don’t worry about losing your money in the bank or about your stock portfolio. Just have a look at USD-INR rate, it has not moved – there is no concern of capital exiting the country. Indian economy is big and resilient to take up such shocks.
And please don’t listen to the fearmongers who want you to run to your bank to withdraw cash. Indian banks are very well capitalized, and they won’t fail.
PNB Scam and Corporate Governance in India!
While India’s image won’t take a hit, this episode does question the Corporate Governance in India. PNB must immediately hold an investor conference call and update everyone on the real size of this scam. For all we know, it might just be a small scam worth few crores!