Image Source -

This article is written by Pratap Alexander Muthalaly, a student of The Government Law College Trivandrum. This article analyses the intricate details of the PNB scam, its overall impact and also the various financial tools and instruments manipulated in the scam.


On February 14th 2018, Punjab National Bank (PNB), disclosed that it had been defrauded out of roughly 1.8 billion dollars. This news shook the nation and all eyes turned to the culprit Nirav Modi, a rich diamond tycoon. This article details the true nature of the fraud, its repercussions and just how Nirav Modi and his associates pulled off one of the biggest bank scams in Indian history.

What is this fraud about

The PNB scam is basically a case of financial fraud that was committed by Nirav Modi and his associates who colluded with senior Punjab National Bank employees. To better understand the fraud and what it is all about we have to understand certain other basic concepts first.

Download Now

SWIFT Transfers

Society for Worldwide Interbank Financial Telecommunications (SWIFT) is a cooperative society headquartered in Belgium. The primary role of SWIFT is to carry secure financial messages from one bank to the other. That is, if one bank wants to send a message to another bank, SWIFT carries the message in a safe and secure way, without altering the message. It is often misunderstood that SWIFT transfers money, this, however, is not the case. SWIFT is not involved in settling or clearing fund transfers, it only transfers secure messages.

In the case of PNB, the two employees directly used SWIFT to move millions of dollars across borders every hour— and bypassed the core banking system (CBS) which processes daily banking transactions and posts updates. 

Letter of Undertaking

Letter of undertaking, (LOU) is basically an instrument used by importers to carry out their business. For example, an Indian businessman has businesses in the US, he procures raw materials from a seller for a certain amount (ex- 100 cr) and may have to pay the amount in a short time which may not be possible at that time. Therefore, the Indian businessman approaches a bank in India and submits security worth roughly the same amount as the fee he is due to pay, and in return asks his bank to issue an LOU. The bank issues an LOU and sends a message to the supplier’s bank through SWIFT, guaranteeing money owed by the Indian businessman. This ensures the smooth conclusion of the business transaction.

In the case of PNB, the LOU’s were issued in favour of Nirav Modi bypassing the bank’s reporting system using SWIFT messages to overseas banks without authorization. Nirav Modi, with the assistance of senior PNB officials, was able to obtain LOUs without submitting any securities. These LOUs were then submitted via SWIFT messages to banks in other countries. 

How the perpetrators got caught

According to a 2018 article by the Hindustan Times, for the past seven years, two employees of PNB were sending unauthorised LOUs.  This was until one of them retired and a new employee joined in his place. In January, when Nirav Modi’s firm asked for a fresh set of guarantees, the new employee demanded collateral. The representatives from Firestar (Nirav Modi and co) responded by saying that they had never been asked for a guarantee in the past. This triggered an investigation which led to the curtains falling and the truth of the fraudulent LOUs coming to light. 

Legal angle

Fraud is essentially defined as any dishonest act or behaviour by which a certain individual gains or has the explicit intent to gain an advantage over another person. In a fraud, the loss caused to the victim is either directly or indirectly. While fraud is not described or discussed in a detailed manner in The Indian Penal Code, there are certain sections dealing with the constituents of fraud. This includes cheating, concealment, forgery counterfeiting and breach of trust.

In a contractual sense, fraud refers to and includes any acts by a party to a contract or with his expressed authority or instructions or by his agents with the intention to deceive another party or his agent or to induce them to enter into a contract. All of this is read in accordance with section 17 of the Contract Act.

In the modern age, banking fraud is on the rise and more prevalent than ever. Compared to  ordinary cases of thefts and robberies, the amount misappropriated in crimes like banking fraud runs into lakhs and crores of rupees. Bank fraud is by law a federal crime in most countries. Simply put, banking fraud is the use of potentially illegal means to obtain money, assets, or other property owned or held by a financial institution, or in some cases to obtain money from depositors by fraudulently posing as a bank or some other financial institution.

Fugitive Economic Offenders Act (2018)

In response to the huge bank scam, the government passed the Fugitive Economic Offenders Act (2018) which came into force on 21st April 2018. The Act was enacted to prevent economic offenders in the ilk of Nirav Modi from escaping the country. Courts are empowered under this Act to confiscate all assets and properties of the offenders who are charged with default over Rs. 100 crores and those who try to evade the charges by wilfully remaining outside the jurisdiction of the Indian judiciary. In accordance with this Act, the fugitive economic offender’s property and other valuable assets are confiscated. 

Impact and resulting aftermath

  1. PNB was essentially left holding bank guarantees worth in excess of  Rs 11,400 crore which it has to pay to a multitude of different parties including the State Bank of India, Allahabad Bank and Union Bank. The said payments were expected over the next few months. 
  2. Furthermore, the banking sector, jewellery sector and the insurance sector were stunted with serious negative repercussions after the findings of the case were reported to the public. 
  3. Big questions arose with regard to the credibility of public sector banks as a whole, and also the whether regulators like the  RBI and SEBI were performing their duties to the required standard.

In response to all this, the Reserve Bank of India immediately banned banks from issuing guarantees in the form of letters of undertaking (LOU) to prevent any further misuse of the medium. It was also decided that the process of issuing LoUs for trade-related credits for imports in India was to be discontinued by commercial banks with immediate effect. The RBI had also directed banks to connect their core banking systems (CBS) to the SWIFT (Society for worldwide interbank financial telecommunication) system by April 30, of that. Meanwhile, Nirav Modi was charged with criminal conspiracy, cheating, dishonesty, fraud, breach of trust and breach of contract and was arrested in London after the release of an arrest warrant against him.

Impact on the Stock Market

The overall value of PNB’s fraudulent transactions was said to be nearly 50 times that of the bank’s 2018 end third-quarter net profit of Rs 230.11 crores. In particular, there were five notable banks that had been directly impacted by the fraud as they had offered credit based on the LoUs that had been issued at the behest of PNB. The said institutions were UBO bank, Allahabad Bank, Axis Bank, Union Bank of India.

Union Bank of India: UBI is said to have suffered a reported loss of 5.8 per cent that led to Rs 633 crores of erosion in its overall market capital at the time (that is, between 12 February closing and 15 February closing). Overall the bank’s negative stock exposure as a result of the PNB fraud stood at a total of Rs 1920 crores. The bank was also reported to have suffered a net loss of Rs 1,249.85 crores in Q3FY18. It’s Gross NPAs stood at 13.03 per cent in Q3FY18 compared to 11.7 per cent in Q3FY17. 

Allahabad Bank: The bank saw a stock price drop of over 9.9 percent that continued till the 15th of February 2018. Moreover, Its market capitalization was said to have suffered an erosion of over Rs 484 crores. The bank’s overall exposure in PNB fraud was calculated as being roughly Rs 2400 crores. In Q3FY18, the bank reported a 5.4 per cent reduction in total income with a net loss of Rs 1263.79 crores. Its gross non-performing assets were also said to have skyrocketed to the value of 14.38 per cent in Q3FY18 in comparison with the reported to 12.51 per cent in Q3FY17. 

Axis Bank: The share price of Axis Bank fell by roughly 3.4 per cent, this downward spiral on up to to 15 February 2018, also, the overall market value was also said to have fallen reportedly by over Rs 4,800 crores. Finally,The bank’s overall exposure in PNB fraud is said to be around Rs 200 crore.

SBI: The State bank of India saw shares plummet by 3.34 per cent, with there being an overall market value drop of over Rs 8,329 crores between the time period of 12 February 2018 and 15 February 2018. Also, its reported exposure to the PNB fraud was calculated to be at 1360 crore. In Q3FY18, the state bank of India was hit with a net loss of Rs 2416 crores compared to the Rs 2610 crores profit in Q3FY17. Furthermore, its gross Non-performing Assets soared from 7.23 per cent in Q3FY17 to a reported high of 10.35 per cent in Q3FY18. 

Impact on LIC

While dealing a deadly blow to major Indian banks, it also had a strong impact on another state-owned entity,  the  Life Insurance Corporation. LIC, which lost a reported amount of Rs 1,400 crore. 

Impact on Jewellery Stocks

In lieu of the shocking developments, the shares of Gitanjali Gem fell by a reported 19 per cent soon after Punjab National Bank’s declared the news of the fraud to the wider public. Also, the stocks of other publicly listed jewellery traders suffered a hit with PC Jeweller witnessing a 19.50 per cent slump to Rs 303.00, Tribhovandas Bhimji Zaveri (TBZ) a recorded 4.32 per cent to Rs 110.60, and Thangamayil Jewellery fell by 2 per cent to 558.55 on BSE. Rajesh Exports was also hit by 1.34 percent to a recorded plummet of Rs 808.70 on the BSE. 


Reforms and lessons learnt

The scam pushed forward the catalyst for a slew of major reforms in the Punjab National bank. It has also seen a recent uprise in the bank’s performance across different indicators. The PNB had a score of 78.4 out of 100 and was ranked first in the EASE (Enhanced Access & Service Excellence)index, According to the report PNB displayed “strong performance” in areas like customer responsiveness, responsible banking, credit off-take and financial inclusion.

Stated below are some of the lessons learnt from the bank scam:

The first notable realization was that banks urgently needed to better manage their operational risks, essentially in the realm of credit, market and operation risks.

Credit risk (CR) and market risk (MR) are primarily related to potential losses from lending and investment activities respectively. Losses of this nature occur in a situation where there is a loan default or wrong valuation value of an investment.

Then we have Operational risk (OR) which works to indicate a failure in any of the banking systems, processes and also the people. OR covers a broad range of products and businesses, in contrast to CR or MR, which are focused on specific transactions.

Also, we must look beyond the banks. It has to be understood that various agencies also need to make changes to their existing behavioural patterns and attitudes in the field,  they must immediately sharpen and update their skills and knowledge of the banking business. Furthermore Internal, as well as statutory, auditors must be capable and also willing to highlight any inadequate processes or potential malpractices being followed by a banking institution. Even if certain specific transactions may manage to slip away undetected, the checking of the loan approval process and its issuance is a must which auditors have to take accountability for.

Thirdly, there is something for the Reserve Bank of India to learn as well. It is undeniable that The Reserve Bank of India (RBI) has been efficient in issuing all the requisite guidelines pertaining to CR, MR and OR. However, it also needs to promote better discipline in OR as so as to ensure better success in its supervisory duties. Moreover, The process of reporting Red Flagged Accounts (RFA) needs to be tested to see whether the correct balance between type-1and type-2 errors is being adopted by the banks in this process.

Finally, the Government of India, as a public policy leader and plan developer, should evaluate the chinks in its armour that have to lead to mishaps such as these. Furthermore it is necessary that the Ministry of Corporate affairs (MCA) take time to carefully review various factors like the disclosure standards of corporates, including banks. However, rather than merely making increases in the number of compliances, the MCA must also carry out a wider review of the disclosure and compliance process, to ensure that the process is as effective and error-free as possible.


The PNB scam has left a more than a noticeable dent on India’s banking sector. A positive outcome of this is that the government is more watchful and attuned to the banking sector and its various happenings. The scam also gives both the government and the reserve bank the opportunity to enact reforms. While the Fugitive Economic Offenders Act is certainly a good start, it must not be the only legislation enacted in this regard. It is crucial that we continue to push for reform in the banking sector, so as to prevent old and well-established banks like the PNB from having their reputations soiled in the coming future.



LawSikho has created a telegram group for exchanging legal knowledge, referrals and various opportunities. You can click on this link and join:

Follow us on Instagram and subscribe to our YouTube channel for more amazing legal content.


Please enter your comment!
Please enter your name here