Another Bank Fraud, Another Diamond Trader and yet Another Weakness in a Public Bank's Systems

Incredible as it may sound, the Oriental Bank of Commerce scam signals an even more disheartening failure of a bank’s risk management functions than the PNB scandal.

The parallels between the two frauds are unmistakable. Credit: PTI

The parallels between the two frauds are unmistakable. Credit: PTI

Close on the hills of the ‘mother of all bank scams’ comes another bank fraud. The Oriental Bank of Commerce (OBC) is not quite in the same league as Punjab National Bank – it is much smaller and comes nowhere near its elder sibling in visibility.

Likewise, Dwarka Das Seth International (DDSI), the company at the centre of the fraud, is no Nirav Modi either – whether in terms of its gross assets, the size of its balance sheet or its hold over the public imagination. Also, the amount at stake here – Rs 380 crore, at last count – is peanuts compared to the nearly Rs 13,000 crore at stake in the PNB saga.

And yet, the parallels between the two frauds are unmistakable. Here was another diamond merchant working his way through the labyrinthine work processes of another public sector bank, and beating the system so completely as to make the bank look like a complete fool. Or worse, like a willing accomplice in his own criminal enterprise.

However, the differences between both scams also need to be flagged for the ordinary citizen’s attention, if only to give an idea of the incredibly varied forms of skulduggery at play in the way a section of the diamond trade may have been abusing banking channels in recent years.

From the facts of the OBC case that have come to light till now, Dwarka Das Seth appears to have been exporting processed and polished diamonds to sundry buyers in the Middle East. Once the shipment had been sent to the buyer, DDSI would draw up its shipping and billing documents and submit them to its bankers (in this case, OBC), requesting them to lend it money against these documents.

Why did it need that money? Likely because there is an agreed credit (‘usance’) period allowed in the underlying export contract – the overseas buyer would pay DDSI only after the lapse of that credit period (typically 90 days), during which period DDSI would stay out-of-pocket.

The financing by banks of such export trade usually takes one of two routes: granting credit limits against a running balance of export receivables that have been routed through the bank concerned (often referred to as an ‘overdraft against export bills’ facility), or by purchasing/discounting export bills (in other words, giving the equivalent amount of rupees to an exporter against his export consignment) on a case-by-case basis.

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Usually, in both options, a certain amount on the value of the export bill(s) tendered to the bank is retained by the bank as “margin”, to be released to the exporter when the export bill(s) in question is/are actually paid by the overseas buyer. The latter option is generally referred to as ‘export bills/foreign bills discounting (EBD/FBD) facility.

Like in any type of credit made available to a client, an EBD line is approved by a bank after a due diligence is done taking into account the client’s business volumes, his credit-worthiness and the adequacy of his cash flows among other things.

An added comfort that is often available to banks extending the EBD facility is a Letter of Credit (LC) that the banker to the overseas buyer may happen to provide to the exporter. The LC is a standardised financial instrument issued in accordance with a universally accepted set of rules governing trade-related documentary exchanges. At a rough estimate, 15% of international trade has the LC mode as its backbone.

The LC, established by a bank on behalf of a client, notifies the client’s suppliers of that bank’s willingness and obligation to pay an agreed sum of money (in exchange of documents showing the despatch of an agreed quantity of an agreed commodity) to such suppliers provided the various terms as set out in the LC are complied with.

Such an LC is a guarantee to the exporter that the buyer’s bank will pay for the export consignment if everything else is otherwise in order. In the hands of the exporter’s bank – in this instance, the OBC – the LC is an assurance from another international bank that if OBC were to lend money to DDSI against an export consignment made in accordance with terms specified in the LC, OBC would be reimbursed by that bank in due course.

Apples and oranges

Herein lies the critical difference between the Nirav Modi and the DDSI cases.

In the former, PNB was the importer’s bank, guaranteeing payment against the import of diamond roughs by Modi. In DDSI’s case, however, OBC was the banker to the exporter of processed diamonds, and held in its hands – or so it thought – LCs supposedly issued by international banks guaranteeing payment against exports made to other countries. Both aspects of the trade are widely known and acknowledged as routine trade transactions. By extending to DDSI finance against export documents covered by LCs, therefore, OBC was performing a routine banking function which has the additional advantage of being low in default risk – for it was backed by what essentially was another bank’s guarantee.

But was that really the position on the ground? Not quite. On the contrary, here is where the fraud came in. As it turns out, the LCs against which OBC lent money were duds, plain and simple. They were either issued by worthless banks with no or negligible net worth (and hence, with insufficient wherewithal to honour their commitments) or – more outrageously – by ones that did not even exist. It appears that DDSI was handing in scraps of paper which had no real value, submitting thereafter to the bank “export documents” whose payment was guaranteed by these scraps of paper alone, and merrily withdrawing large sums of money as ‘export realisation’.

All commercial banks across the world have a system of due diligence done on one other so that the risks of doing inter-bank business are evaluated and quantified. A universally used metric called BERI (Bank Exposure Risk Index) is used for the purpose and this is an aid to the determination of risks underlying inter-bank exposures. A good BERI score points to the high desirability of assuming an exposure on the counterparty bank, while an unsatisfactory score would indicate unduly high risks. The BERI metric is also used by banks to determine for itself the level of exposure it intends to assume on each bank it wants to do business with. The BERI index is thus an essential apparatus of every bank’s risk management function.

It is unlikely – why, it is impossible – that an OBC branch handling international trade was not aware of or party to the BERI protocol. The fact that, despite this, it went on discounting bills covered by LCs apparently issued by banks of dubious or no standing establishes beyond all doubt that this was a massive fraud, and nothing else.

Frauds being so common to the Indian banking space now, however, this in itself would perhaps not have been so shocking if this quite egregious thuggery were detected by the bank’s usual oversight structures and systems including inspection, audit or back-office monitoring of the Forex Dealing Rooms. It is inconceivable that such a fraud, which encompasses so many different layers of the bank’s operational and oversight structures, was anything other than organised, coordinated malfeasance. If, as seems to be the case, this had been going on for some years – even for some months – then it speaks of a stinking rot that has spread far and wide inside the bank.

It may sound extraordinary, but this is a scam even wider in its deadly scope than the Nirav Modi fraud. In PNB, the fraudsters exploited the relative opacity of the SWIFT apparatus to most employees other than those entrusted with the task of managing and monitoring it. Leaving NOSTRO account unreconciled was a glaring error, but – let us face it – that area is a weak link in perhaps some other banks’ risk management armour also. The system-related issues (say, the fact that the SWIFT system did not interface with the accounting platform), are also not unknown in some other banks. It is also possible that the people involved in the fraud cleverly gamed the system by running Ponzi-like projects of mushrooming growth.

But the OBC fraud operated at so elementary a level that it is hard to believe that something like this could still happen today. And the web of this scam is likely to be wider than the PNB scam, for this same reason.

Every failure of risk management in public sector banks sends out a signal to the supporters of privatisation. Even as accomplished an economist as Arvind Subramanian would have known that he was setting the cat among the pigeons when he said, the other day, that the ownership of these banks called for a review in the context of the PNB fraud.

Demoralised and despondent, public sector banks are unable, perhaps also unwilling, to speak out in their own behalf, and spell out both the ills plaguing themselves and the possible remedies to the condition. Least of all, they have the necessary self-assurance today to clearly state why the public sector remains a vital component of the national economy, and how its demise can only exacerbate the many problems assailing the country from all sides.

Soon, it may be too late for their voices to be heard over the cacophony of other voices baying for their frank blood. Will India’s public sector banks try and make their case at last for once now? It may indeed be now or never.

Anjan Basu worked for one of India’s largest commercial banks for over three decades, his assignments have taken him all across the country as well as outside it.

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