CHAPTER 4: CASE STUDIES ON

BANK FRAUD IN INDIA

136
4.1 INTRODUCTION

Weaknesses in the Legislative and Regulatory systems give rise to opportunities, for the
unscrupulous, to commit Bank Fraud. These frauds cause tremendous damage to the trust of
the general public in the Financial System, especially banks, leading to a slowdown in the
economy and development of the Nation. The huge amount of money lost to frauds, coupled
with the mandatory requirement on Banks to make 100% provision in cases of frauds, results
in reduction of capital that could have been utilized for developmental purposes and slows the
economic growth.

In this Chapter, some of the frauds that have rocked the Banking Industry in recent years
have been discussed. These frauds, most still under investigation, bring out the weaknesses in
the system and how those entrusted with the depositors money use their position and
knowledge to gain individual benefits. The case studies cover Public Sector Banks, Private
Sector Banks and Cooperative Banks.

4.2 PUNJAB NATIONAL BANK FRAUD CASE

Punjab National Bank (PNB) is the second largest Public Sector multinational bank in India,
with ―10,528 domestic branches, 2 international branches, 13,506 ATMs and 12,478
Business Correspondents‖233 ( as in September 2021). It began its journey in 1894 with the
founding members belonging to different faiths, coming from diverse backgrounds and
opened for business to public in 1895. The main objective of founding the Bank was part of
the Swadeshi Movement to provide India with a national bank with Indian Capital. 234 PNB
was nationalised in 1969 and up until then was one of the largest banks in the Private Sector.

Four years ago, in February 2018, perhaps the biggest ever fraud perpetrated in the Banking
Industry in India came to light, when PNB informed the Stock Exchange that fraudulent
transaction worth Rs.11394.02 crores had been detected by it, involving one of its branches in
Mumbai.235

233
Punjab National Bank. "Profile Of Punjab National Bank." Accessed January 10, 2022.
https://www.pnbindia.in/downloadprocess.aspx?fid=lwS2UC0Bvme58fKJBnQ9ew==.
234
Punjab National Bank ,. n.d. "Origin of PNB." Accessed November 20, 2021.
https://www.pnbindia.in/origin-of-PNB.html.
235
Krishna, Navmi. 2018. "All you need to know about Nirav Modi and the $1.77-billion PNB fraud." February
17. Accessed June 6, 2020. https://www.thehindu.com/business/Industry/all-you-need-to-know-about-nirav-
modi-and-the-177-billion-pnb-fraud/article22753973.ece.
137
The fraudulent transactions, according to the PNB note to the Stock Exchange, were carried
out between the years 2011 to 2017, wherein multiple unauthorized Letters of Undertaking
(LoUs)236 had been issued to various companies owned by jeweller Mr. Nirav Modi, by two
junior level employees of a Mumbai Branch of PNB, without any collateral securities.237

The fraudulent transactions came to light after one of the accused employee, Mr. Gokulnath
Shetty, Deputy Manager of the Branch, retired in January 2018 and a fresh application for the
issuance of an LoU was declined by his successor, without any collateral security being
furnished for the same. The representatives of Mr. Nirav Modi asserted that no collateral
securities had been asked for by the Bank while issuing the previous LoUs. According to
reports, Mr. Shetty logged in to PNB‘s SWIFT system with passwords that permitted him to
issue, verify, approve and also receive the confirmation message of creation of loan238 with
the help of Mr. Manoj Kharat, a Single Window Operator of the same branch.

PNB vide its clarification sent to the Stock Exchanges, confirmed that: ―On 16.01.2018, the
partnership firm of Nirav Modi group approached our branch at Brady House, Mumbai and
presented a set of import documents with a request to allow buyers' credit for making
payment to the overseas suppliers. Since there was no sanctioned limit in the name of the
above firms, the branch officials requested the firms to furnish at least 100% cash margin for
issuing Letter of Undertaking (LOU) for raising buyer's credit. On denial, the firms contested
that they have been availing such transactions since past several years. On scrutiny, it was
observed that earlier Issuance of LOU had been made by the branch officials through SWIFT
without obtaining approval of the competent authority, necessary applications from Importer,
documents of import, legal documentation with bank and also without making entries in
Bank's trade finance module of CBS system.‖ 239

This alerted the successor of Mr. Shetty of the lapses in banking operations, misappropriation
of the monies advanced and the misuse of access privileges by bank employees. From 25

236
LoU is a type of bank guarantee, issued by a bank document, to a foreign branch of an Indian Bank, which
enables a customer to get short term buyer‘s credit from the foreign branch to complete their business
transactions with foreign entities.
237
Kaushik Dora Hanumantu, Vidula Worlikar, Sundaravalli Narayanaswam. 2019. "The Punjab National Bank
scam: Ethics versus robust processes." Journal of Public Affairs an International Journal (Wiley Online Library)
19 (4). Accessed February 21, 2021. doi: https://doi.org/10.1002/pa.1952.
238
Bandyopadhyay, Tamal. 2018. "The anatomy of the PNB fraud." Mint, February 19. Accessed February 2,
2021. https://www.livemint.com/Opinion/oiMKS98wBunYNviWCVq6hJ/The-anatomy-of-the-PNB-fraud.html.
239
Punjab National Bank. 2018. "Clarification/confirmation on news item." Delhi, February 2. Accessed
February 2, 2021. https://taxguru.in/wp-content/uploads/2018/02/Clarification-confirmation-on-news-item.pdf.
138
January 2018 to 12 February 2018, investigations revealed unauthorized LoUs, Foreign
Letters of Credit and Inland Letters of Guarantee, amounting to a total of Rs, 11394.02 crores
in the group accounts of Nirav Modi Group and M/s Gitanjali Group among others. 240 PNB
submitted an FMR-I Report, (as per the fraud reporting format of the Master Directions on
Fraud Reporting) to RBI and registered a criminal complaint with CBI against the accused
including the bank employees involved, for fraud by cheating, criminal conspiracy and abuse
of official position. Another complaint was also filed with ED, considering the value of the
fraud.

The fraud involves various people, bank instruments and systems. To better appreciate the
anatomy of the fraud, it is pertinent to understand the factual background leading to the
commission of the fraud.

The prime accused include Mr. Nirav Modi, a jewellery designer and merchant, Mr. Mehul
Choksi, maternal uncle of Mr. Nirav Modi and founder of Gitanjali Group, Mr. Gokulnath
Shetty, Deputy Manager at the Brady Branch, Mumbai and Mr. Manoj Kharat, a Single
Window Operator at the same Branch.

Nirav Modi rose to fame as a jewellery designer after one of his designs, named ―Golconda
Lotus Necklace‖ was auctioned at Christie‘s Hong Kong for $3million.241 He launched his
own brand and opened stores in Delhi and Mumbai in 2014 and 2015 respectively, followed
by other outlets in New York and Hong Kong242. For his jewellery, he wanted to import
diamonds and pearls and thus, applied for a loan in foreign currency as it was cheaper, easier
and quicker than getting approvals for foreign transactions and was not affected by
fluctuations in the foreign currency exchange rates.243 Mr. Modi, to avoid the complications
of sanctions and collateral securities involved in Loan Accounts, applied for LoUs as
guarantee to obtain short-term buyer‘s credit from foreign Branches of Indian Banks.

It is important to understand the nature, liability of issuer and Regulatory Framework of

LoUs and also the working of SWIFT before proceeding further with the modus operandi of
the fraud.

240
Ibid
241
Castelino, Meher. 2015 . "Nirav Modi – Diamantaire Extraordinaire." December 25. Accessed February 3,
2021. https://www.theluxurychronicle.com/nirav-modi-diamantaire-extraordinaire.
242
Narayan, Khushboo. 2018. "The rise and fall of Nirav Modi." Indian Express. June 26. Accessed February 4,
2021. https://indianexpress.com/article/india/the-rise-and-fall-of-nirav-modi-pnb-scam-5068143/.
243
Supra Note 233, Pg 3
139
  Letter of Undertaking is a type of Bank Guarantee, issued by a bank to its customers
enabling them to avail short term trade credit from a foreign branch of an Indian bank.
These LoUs are in the form of trade credits for import of goods to India and are not
issued for retail transactions. LoUs, therefore, are a guarantee to the foreign branch of
the Indian bank that the Indian branch will settle the outstanding of the customer for
whom the LoU has been issued in foreign currency, in case the same is not repaid by
the customer. These being short term credit facilities, generally have a tenure of 90
days to an year for the repayment of the credit extended (in case of non-capital
goods).
Banking Regulations require that for the issuance of LoUs as security for trade credit,
the customer applying for the same has to provide margin money or collateral security
to the issuing bank, whereupon the bank sanctions a credit limit to the customer. This
ensures that in case the LoU matures and the issuing bank‘s liability arises, it is
secured by the margin money or collateral security. Moreover, the issuing of LoUs,
including the limit of credit and tenure, is governed by the Directions of RBI244 issued
under the powers given by the Foreign Exchange Management Act, 1999 and
Governments Policy regarding Foreign Trade. According to Master Circular,
DOR.STR.REC.66/13.07.010/2021-22245 dated 09 November 2021, RBI issued
updated guidelines in respect of issuance of Bank Guarantees. These include general
guidelines like:
I. Banks should generally be cautious while issuing performance guarantees and
confine themselves to financial guarantees.
II. Banks should provide guarantees of shorter duration and no guarantee should
have a maturity period of more than 10 years.
III. Before issuance of guarantees, banks must ensure financial stability and the
ability of the customer to reimburse the bank in case bank‘s liability is called
for the payment.
IV. To safeguard the bank from internal risks, Bank Guarantees securing credit of
value Rs 50.000 and above, must be signed by 2 officials jointly. This would
244
RBI, vide its directions issued in 2004, had permitted all authorized dealer banks to issue Guarantees, LoUs
or Letter of Comfort in favour of foreign banks, suppliers and financial institutions, upto $20 Million per
transaction for a period of 1 year for importing non-capital goods except gold. After the PNB fraud came to
light RBI, vide its notification (A.P. (DIR Series) Circular No. 20) dated 13 March 2018 , discontinued the
facility of issuance of LoUs or Letter of Comfort as Trade Credit by Authorized Dealer Banks, leaving only
Bank Guarantees and Letter of Credit as issuable instruments.
245
https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=12189
140
 help reduce the chances of malpractices and frauds by bank employees. In case
this system is not followed in some exceptional cases, then such instruments
must be scrutinized by auditors.
V. Verification by auditors(internal and external), especially in case of all types
of Bank Guarantees, is an important and crucial aspect of internal control.
Banks are subject to various audits, one of which is a Concurrent Audit, which
reduces the time interval between a transaction and its independent
assessment. It is considered as an early warning system, which enables the
detection of any irregularities or errors that are detrimental to the bank‘s
business and also helps in preventing fraudulent transactions. Banks have been
advised by RBI to carry out concurrent audits in areas where the risk
exposures of the bank are high. LoUs being high risk operations, banks must
have concurrent audits of the same, besides the periodic Branch Audits and
Annual Audits.
Consequent to the fulfillment of all necessary requirements and upon the satisfaction
of the issuing bank, regarding the adequacy of the collateral security(which is
generally higher than the value of the credit sought), the LoU is processed and a
message is sent to the foreign branch using the SWIFT network, advising the branch
of the issuance of the LoU. Once the message is received by the intended foreign
branch, the amount is released by it and credited to a specific account called the
NOSTRO Account246 of the issuing bank(home branch). Once the amount is credited
(in foreign currency) to this account, the customer can utilize the amount to make
payments to the supplier from whom he intended to purchase the goods or services.
For example, PNB issued an LoU in favour of an importer, to the foreign branch of
Union Bank of India and conveyed the same through SWIFT. Once the message was
received, the approved amount was transferred to PNB‘s NOSTRO Account, as a loan
to the importer, who utilized this money to complete his transaction with the foreign
supplier. Once either the tenure is up or the importer has realised his input by reselling
the imported goods, he will pay the loan advanced plus interest to PNB, which in turn
will settle the accounts with the overseas branch of Union Bank of India.

246
It is an account of an Indian Bank, that it holds in foreign currency, in either its own foreign branch or
overseas branch of another bank to enable its customers to transact in foreign currency and settle their trade
transactions.
141
  Swift and its use in the Fraud.
SWIFT is a communications network, that provides for globally set standards for
communication between member banks, which are secure and understood by the
banking institutions without any ambiguity. The services provided by SWIFT
facilitate not only secure transmission of messages between entities, but also an audit
trail of all communications, ensuring regulatory compliance.
When a bank issues any LoU, a message is sent to the overseas branch of the Indian
bank, conveying the credit transfer to the customer, using the SWIFT network. This
message acts as an instruction to the receiving bank to transfer the approved amount
in foreign currency to the NOSTRO account and also acts as a guarantee by the
issuing bank.
Every member bank is identified with a unique code, known as the SWIFT code,
which is alphanumeric and clearly identifies the bank, country, city and branch. This
enables clear identification of the initiator of the message and the recipient. To initiate
a transaction using SWIFT, there are a minimum of three individuals required, namely
a maker, a checker and a verifier, before the transaction is approved and issued. Each
of the officials have to login to the system using their access passwords and fill in the
requirements as per the nature of the transaction being initiated.
The SWIFT network has to be integrated with the CBS of the bank, ensuring that any
transaction done using the SWIFT network is recorded within the CBS.

Having understood the nature of LoUs and working of the SWIFT network, the lapses in the
procedure followed regarding the issuance, abuse of access privileges to initiate and approve
the transactions using SWIFT and use of insider knowledge of the banking system are now
being discussed to better understand the modus operandi of the fraud.

 Lapses in Procedure
• According to RBI directions, any guarantee issued by a bank should have
some collateral security in the form of assets or margin money, either
equivalent to or more than the guarantee. The LoUs, in this instance, were
issued without any collateral security or margin money.
• The bank sanctions a credit limit, based on the collateral security or margin
money provided by the customer and also previous credit history of the

142
 customer. In this case, no credit limits were sanctioned to Mr. Nirav Modi or
any of the groups entities.
• The security measure in case of SWIFT transactions requiring a minimum of
three personnel was bypassed by the employees involved, with a single person
Mr. Shetty, being the maker, checker and verifier of the transaction.
• Once the message is received by the Foreign branch, a receipt message is sent
back, confirming the transaction. His message is generally received by a
person other than the above-mentioned three. In the case of PNB, either the
receiving banks did not send the confirmations or were received by Mr. Shetty
himself.
• The transactions were not recorded in the CBS of PNB, which keeps a record
of all transaction of the bank.
• Concurrent Audit of high risk transactions, Branch Audits and Annual Audits
are mandatory requirements for all Banks and Financial Institutions. In the
present case, there were gross lapses on the part of both the internal and
external auditors, as they failed to detect the LoUs for a period of almost 7
years. NOSTRO Accounts require to be regularly reconciled and mandatorily
require to be audited by either SWIFT messages, emails or documents, to
confirm the transactions, which in the present case appears to have not been
done. Besides this the increase in the NOSTRO Account should have been
investigated by the internal as well as external auditors, which surprisingly, in
the present case, seems to have not been noticed by the auditors.
• Most Banks and Financial Institutions regularly rotate their employees, as part
of their internal risk management strategy and sensitive positions are
monitored closely247. In this case, however, one of the accused employees, Mr.
Shetty was in the same position and branch for over a period of 7 years(till he
retired).

247
Supra Note 238
143
  Abuse of Position and Insider Knowledge
• The accused bank employees were aware of the fact that the SWIFT network
was not fully integrated with the bank‘s CBS and used this knowledge to their
advantage, by not logging the SWIFT transactions thereon.248
• According to reports, physical documents of the transactions were destroyed
to hide any evidence of the fraudulent transactions.249
• Mr. Shetty, being the Deputy Manager, was authorized to clear transactions
worth Rs. 10 lakh to Rs. 25 lakhs only. However, according to newspaper
reports, Mr. Shetty authorized and cleared multiple transactions amounting to
Rs 1 crore, the highest being that of Rs. 221 crores.250
• According to an internal investigation report by PNB, Mr. Shetty, the then
Deputy Manager of the Foreign Exchange Department of the Branch, had
complete access to the bank‘s internal systems and thus was able to verify
transactions above his sanctioned limits. The report further stated that in the
year 2017, Mr. Shetty was authorized as both the maker and checker of
entries.251 This enabled him to further escape detection. Mr. Shetty, according
to a news report, admitted to the CBI that he had access to Level 5 password
to the SWIFT system252, which is generally provided to an Assistant General
Manager level. The Report further stated that Mr. Shetty admitted to having
shared the password with employees of Mr. Nirav Modi.

The above lapses and abuse illustrate how the fraud was perpetrated by just a couple of
insiders, of whom one of the accused, Mr. Manoj Karat, has alleged that he is being used as a
scapegoat, and that he was just following orders from his senior officials.

248
Abhirup Roy, Aditya Kalra and Euan Rocha, Reuters. 2018. How PNB fraud happened: A 162-page report
lays bare the lapses. Newspaper, Livemint.com. Accessed February 4, 2021.
https://www.livemint.com/Companies/QVrxBXaZBX2t82KkFBSAOL/How-PNB-fraud-happened-A-162page-
report-lays-bare-the-laps.html.
249
Supra Note 234
250
Times of India. 2018. How one man enabled India's largest banking fraud. Newspaper, Times of India. Accessed
February 4, 2021. https://timesofindia.indiatimes.com/business/india-business/how-one-man-enabled-indias-largest-
banking-fraud/articleshow/64744655.cms.
251
Ibid
252
Jain, Meetu. 2018. PNB scam: Gokulnath Shetty admits to giving access of LoU issuing software to Nirav
Modi's aides. Newspaper, India Today. Accessed March 5, 2021. https://www.indiatoday.in/india/story/pnb-
fraud-gokunath-shetty-admits-to-sharing-password-of-software-used-to-issue-lous-with-nirav-modi-s-aides-
1172029-2018-02-18.
144
The fraud doesn‘t involve just the issuance of unauthorised LoUs, according to CBI and ED
investigations, the money raised through these LoUs was in fact not used to make trade
payments but was either used to repay old loans or to fake entities and used as a medium for
money laundering. 253

According to various news reports, the import papers presented to PNB, in respect of many
transactions, were fake and were sent by firms of Mr. Modi. Based on these papers, PNB
would release the payment in favour of these entities. However, instead of actual purchase of
gems, the money was used to pay off previous loans or brought back to India through various
fictious transactions. According to ED, the trail of these transactions revealed about 20 shell
firms, mostly based in Hong Kong and Dubai. The case involved the use of methods like
Round-Tripping254 Kite Flying255 and Hawala transactions256.

Newspaper reports that followed the fraud story, reported that while investigating the
bankruptcy proceedings of three US based corporations of Mr. Modi, the investigators found
that a particular diamond was sold by a US based company, Firestar Diamond Inc., which is
indirectly owned by Mr. Modi, to a Hong Kong based company called Fancy Creations
Company Ltd., allegedly a shell company under the control of Mr. Modi, sometime in August
2011 for about $ 1.1 million. The diamond described as a ―fancy vivid yellow orange cushion
cut diamond‖ was, two weeks later, shipped by Solar Export, a partnership firm founded by
Nirav Modi Family Trust, back to Firestar Diamond Inc. for $ 183,000. A week later, the
same diamond was again shipped back to Fancy Creations Company Ltd., in Hong Kong, for
$1.16 million. After two weeks of this transaction, A. Jaffe, a New York based diamond
company owned by Mr. Modi, sold the diamond to another company, World Diamond
Distribution, based in United Arab Emirates, which the Report of the investigators describes

253
Hindustan Times. 2018. Punjab National Bank Fraud an explainer on what we know so far. Newspaper,
Delhi: Hindustan Times.com. Accessed February 6, 2021. https://www.hindustantimes.com/india-news/punjab-
national-bank-fraud-an-explainer-on-what-we-know-so-far/story-d6LHHPoimqorJtaUZ3QoBK.html .
254
Round Tripping is a method where a product is traded repeatedly in back-to-back transactions, making it to
appear as multiple transactions between unrelated entities, thereby increasing the value of the product with each
new transaction. In fact, the entities involved in the trading are related to each other.
255
Kite Flying is method where a new loan is taken to pay off a previous loan that has become due. By using
this method, the perpetrators build a good credit history, without actually ever having repaid any amount back.
The new loan is always of a higher value to cover both the principal and the interest due thereon.
256
Hawala is an alternative or parallel remittance system. It exists and operates outside of, or parallel to
traditional banking or financial channels. It is a way to transmit money without any movement of the currency.
Hawala transactions are anonymous as no official records are kept and based on trust. As no records are kept
and the transactions are done in cash, hawala transactions are used to evade taxes and launder money and are
illegal in India.
145
as another shell company owned by Mr. Modi, for $ 1.2 million. According to the Report of
the investigators, this round tripping, between the years 2011 to 2017, which eventually
amounted to about $213.8 million, created the shipping invoices that were presented to PNB
for obtaining the LoUs. 257

CBI, ED and Serious Fraud Investigation Office (SIFO), the investigating agencies involved
in the case, found during their investigations that Mr. Nirav Modi and his maternal uncle, Mr.
Mehul Choksi, owner of Gitanjali Gems, used hawala transactions to bring the money lent to
them, for making the payments for the imports, back to their accounts in India, using shell or
dummy companies. According to the officials investigating the fraud, the total amount
involved in the fraud was Rs. 12,300 crores; Mr. Modi was responsible for transactions worth
Rs. 6,500 crores and the remaining Rs. 5,800 crores worth of transactions involved Mr.
Choksi and his company.258

The PNB Fraud raised many questions with regard to internal controls, reconciliation of
accounts and auditing. It highlighted the gross lapses in the Bank‘s Internal Governance
Policies, the risks posed by Insiders in E-Banking Services and also Regulatory lapses. In the
aftermath of this fraud, besides PNB left to honour its obligations under the LoUs, the
credibility of the Indian Banking Industry and the role of the Regulator, i.e., RBI, was
questioned. RBI‘s immediate response to the fraud was the issuance of a notification
discontinuing the issuance of LoUs.

Both Mr. Nirav Modi and Mr. Mehul Choksi left India before the fraud was exposed and
were declared as fugitives. This was not the first case where persons accused of committing
economic offences in India had fled the country to escape prosecution. In order to bring to
justice and punish persons accused of economic crimes, the Indian Parliament passed the
Fugitive Economic Offenders Act(FOEA), 2018 with an objective of providing ―measures to
deter fugitive economic offenders from evading the process of law in India by staying outside
the jurisdiction of Indian courts, to preserve the sanctity of the rule of law in India..‖259 A

257
Saul, Josh. 2018. Nirav Modi‘s bank fraud fueled by FedEx‘d gems: Report. Newspaper, Hindustan Times.
com. Accessed March 6, 2020. https://www.hindustantimes.com/business-news/nirav-modi-s-bank-fraud-
fueled-by-fedex-d-gems-report/story-y7fDwVBvJ4c7Dr07USXLiO.html.
258
Singh, Vijay V. 2018. Nirav Modi got back PNB stash via hawala route. Newspaper, Times of India.
Accessed April 4, 2021. https://economictimes.indiatimes.com/news/politics-and-nation/nirav-modi-got-back-
pnb-stash-via-hawala-route/articleshow/63392366.cms.
259
Preamble to the Fugitive Economic Offenders Act, 2018. https://legislative.gov.in/sites/default/files/A2018-
17.pdf
146
Special Court was set up to hear the Nirav Modi Case under the FEOA, 2018, which allowed
ED to confiscate assets belonging to Mr. Modi, that were not hypothecated or pledged to
PNB and attach the assets under the provisions of FEOA, 2018.

The above case study highlights all the risks that an Insider poses in the Banking Sector and
the need to have stringent internal controls.

4.3 PUNJAB AND MAHARASHTRA COOPERTAIVE BANK FRAUD

Punjab and Maharashtra Co-operative Bank (PMC Bank) is among the top ten largest Co-
operative Banks in India. PMC Bank was founded in 1984 and started operating as a single
branch Cooperative Bank ,from 13 February 1984 in Sion Maharashtra. RBI conferred the
status of a Scheduled Bank to PMC Bank in the year 2000. Till date, PMC Bank is the
youngest bank to have been conferred this status. Further, in 2004, the Bank was given Multi-
State status by the Central Registrar of Co-operative Societies, which paved the way for it to
enter into the National Platform. Furthermore, in 2011, The RBI gave to the Bank
‗Authorised Dealer Category 1‘ Licence for Foreign Exchange Business.260 In 2019 PMC
Bank was operational in States of Maharashtra, Delhi, Karnataka, Goa, Gujarat, Andhra
Pradesh and Madhya Pradesh with 137 branches.261

Just over a year after the PNB Fraud, in September 2019, the confidence of people in the
Banking Sector was once again shaken, when its Managing Director(MD) and Chief
Executive Officer(CEO) Mr. Joy K Thomas confessed to anomalies in its balance sheets and
other fraudulent activities that took place in the Bank beginning in the year 2008.262RBI
imposed operational curbs on daily banking activities and withdrawal of money for 6 months
and appointed Mr. J.M. Bhoria as the Administrator of the Bank. These restrictions came as a
shock to the depositors, with a few even losing their life as they believed that they had lost
their life‘s savings.

260
https://www.pmcbank.com/english/AboutUs.aspx
261
Adhikari, Anand. 2019. "What you must know about Punjab and Maharashtra Co-operative Bank." Business
Today.in. September 24. Accessed June 5, 2020. https://www.businesstoday.in/industry/banks/story/what-you-
must-know-about-punjab-and-maharashtra-co-operative-bank-230726-2019-09-24.
262
Khan, Mohd Asim. 2019. What is PMC Bank Fraud and how it started. Newspaper, Nationalheraldindia.com.
Accessed December 1, 2021. https://www.nationalheraldindia.com/india/explained-what-is-pmc-bank-fraud-
and-how-it-started 1/12/2021.
147
According to the confession of Mr. Thomas, he had actively concealed loan defaults, not only
from the auditors but also the Banks‘ Board and RBI, of one corporate borrower, Housing
Development and Infrastructure Ltd (HDIL), a real estate firm, which amounted to Rs. 6,500
crores or approximately 73% of its total Loan Portfolio. 263

The PMC Bank- HDIL association dates back to 1986-87, when the Bank was facing serious
financial issues and Mr. Rakesh Wadhawan (Director of HDIL at the time the fraud was
revealed) and some other companies, invested in the Bank, and rescued it from closure on
two occasions.264After this, PMC Bank became the banker for HDIL, which provided large
volume of business to the Bank. According to Mr. Thomas, HDIL moved its business from
PMC Bank in 2007, due to massive expansions and the former‘s need for large capital
investments. However, PMC Bank approached the Company to continue its business with
them, as its move had impacted PMC Bank‘s business, and the association once again
resumed.265 Besides this, Mr. Waryam Singh, who was appointed as Chairman of PMC Bank
in 2015 for a period of 5 years, had financial interests in HDIL, having held 1.91% stake till
2017266

HDIL was one of the largest real estate developers in Mumbai and had secured the slum
development project of Mumbai International Airport Ltd. The troubles began around 2011,
when the company started facing liquidity issues due to a series of delays in the project,
which were compounded by changes in the regulatory requirements coupled with a slowdown
in the real estate sector. One of the other bank‘s from whom HDIL had borrowed capital,
filed a case in the National Company Law Tribunal (NCLT) for the recovery of its loans.
PMC Bank at the same time had advanced another loan to HDIL, which allegedly was
utilized to pay the dues of Indian Bank.267

However, PMC Bank instead of classifying the loan accounts as NPA, kept reporting the
same as standard accounts (meaning that there were no delays in repayment). According to

263
George Mathew, Anil Sasi. 2019. PMC bank fraud case: Several red flags fluttered right under RBI‘s nose .
Newspaper, The Indian Express. Accessed January 8, 2020. https://indianexpress.com/article/business/banking-
and-finance/pmc-bank-fraud-case-several-red-flags-fluttered-right-under-rbis-nose-6061451.
264
Sapam, Bidya. 2019. Behind HDIL downfall lies a failed slum project that became financial drain.
Newspaper, Livemint.com. Accessed August 7, 2020. https://www.livemint.com/industry/infrastructure/rise-
and-fall-of-hdil-a-story-of-flashy-cars-and-crisis-ridden-infra-projects-11570193940389.html
265
Supra Note 258
266
Kapoor, CA Rohit. 2019. "PMC Crisis- An In-depth Analysis." taxguru.in. October 7. Accessed July 10,
2020. https://taxguru.in/rbi/pmc-crisis-depth-analysis.html.
267
Ibid
148
Mr. Thomas, the above was done to avoid any regulatory actions from RBI for flouting its
directions and also to save the Bank from reputational losses. Mr. Thomas in his letter
claimed that another reason for not classifying these loans as NPAs was that then the Bank
would not have been able to charge interest on these loan accounts, which would have
resulted in the Bank sustaining losses in their books and hampering the Bank‘s growth. 268

According to the letter sent by Mr. Thomas to RBI, he explained that ― Since the bank was
growing, the statutory auditors, due to their time constraints, were checking only the
incremental advances and not the entire operations in all the accounts. They scrutinised the
accounts which were shown by us.269‖ He further explained that till 2015 RBI inspections
only checked a few of the top borrower accounts, branch wise and thus, they were able to
hide the same. It was only in 2017 when RBI inspections asked for the Advances Master
Indent of the Bank for verification of its loan books, that the need to create dummy accounts
arose. To hide the exposure of the Bank to one group, the loans were broken down to lesser
values and shown as loans against deposits, to match the outstanding balances as reflected by
the balance sheets of the Bank.(Refer Annexure III- Original Letter sent by Mr. Thomas to
RBI). According to one newspaper report, approximately 21,049 fake accounts were opened
to conceal 44 loan accounts belonging to HDIL.270

According to some reports, the revelation by Mr. Thomas came after a whistleblower
informed RBI of the suppression of the NPAs by PMC Bank and RBI started its
investigations into the affairs of the Bank.

An FIR for cheating, criminal breach of trust, forgery, criminal conspiracy and using forged
document was filed against Mr. Joy Thomas, Mr. Waryam Singh from PMC Bank and HDIL
Directors Mr. Sarang Wadhwan and Mr. Rakesh Wadhwan as the primary accused. The
Economic Offences Wing of Mumbai Police, that was investigating the case, reported that
most of the fake accounts that opened to conceal the loan accounts of HDIL, belonged to

268
Times of India. 2019. "Suspended PMC Bank MD Joy Thomas' letter to RBI: Full text."
timesofindia.indiatimes.com. October 1. Accessed August 12, 2020.
https://timesofindia.indiatimes.com/business/india-business/suspended-pmc-bank-md-joy-thomas-letter-to-rbi-
full-text/articleshow/71388501.cms .
269
Ibid
270
Singh, Hemant. 2019. "PMC Bank Fraud Case: Full detail of the Bank Fraud." jagranjosh.com.
October 7. Accessed November 15, 2020. https://www.jagranjosh.com/general-knowledge/pmc-bank-fraud-
case-1570456027-1.
149
account holders that had passed away or had closed their accounts with the PMC Bank.271
The investigations further revealed that the accounts were only entries made in the Advances
Master Indent for the purpose of the RBI inspection and were never entered in the Bank‘s
CBS.

The question that arises here is, how the PMC Bank, especially its MD, was able to conceal
such large defaults without detection. A more pertinent question is why the defaults were
concealed and why loans were extended even after the first defaults happened?

To answer the first question, it is important to understand the incorporation and regulation of
Co-Operative Banks. Cooperative Banking in India began in the pre-independence era to
fulfil the banking needs of the unbanked and underbanked, like the rural and agricultural
sectors and divided into two segments, namely UCB and RCCS. Cooperative Banks are
registered Cooperative Societies under either the State Cooperative Societies Act or the Multi
State Cooperative Societies Act, 2002 and came under the Regulation of RBI in 1966, vis-à-
vis, the banking business carried on by such cooperative societies that were rendering
Banking Services to their members. Thus, Cooperative Banks, were subject to the same
regulatory aspects as Commercial Banks regarding grant of licence, maintenance of cash
reserves, liquidity ratios, inspection by RBI etc. However, the management or administrative
aspects were controlled by the Registrar of Cooperative Societies, which included matters
like selection of the Management and/or Board of Directors, auditing guidelines etc.

This duality of control over Cooperative Banks, impacted RBI‘s capability in taking
corrective measures vis-à-vis irregularities. The Banking Regulation Act, 1949 was amended
in 2020 with the objective of strengthening Banking Services in the Cooperative Sector and
protecting the interests of depositors by empowering RBI with enhanced supervision,
especially in matters of governance and reconstruction(this was a post PMC fraud corrective
action).272

To answer the second set of questions it is important to know the RBI Regulations in respect
of Loans by UCBs and classification of NPAs.

271
Business Today. 2019. "PMC Bank crisis: Fictitious accounts created by lender belonged to dead people,
says Mumbai Police." businesstoday.in. October 6. Accessed September 15, 2020.
https://www.businesstoday.in/industry/banks/story/pmc-bank-crisis-fictitious-accounts-created-by-lender-
belonged-to-dead-people-says-mumbai-police-232062-2019-10-06.
272
Supra Note 81
150
  The maximum limit of advances or loans that a UCB was permitted to extend to a
single borrower or group of borrowers was fixed by RBI at 15% and 40% respectively
of the capital funds(paid up capital and free reserves) of the UCB.273
 Further, RBI, on prudential norms, vis-s vis classification of assets and provisioning
of advances by UCBs, vide its Master Circular, issued in 2015, required UCBs to
declare assets as NPA, in case of term loans, in case the principal and/or the interest
thereon remained unpaid for 90 days from the date they became due.274
 In 2016, all entities regulated by RBI were required to update their KYC requirements
and maintain records of all accounts/ transactions for a period of five years and also
furnish details to the Director of Financial Intelligence Unit-India, all information
regarding transactions mentioned in Rule 3 of the Prevention of Money Laundering
(Maintenance of Records) Rules, 2005.275 According to Rule 3 of the said Rules,
banks were required to maintain records of all advances and loans.

Having explained the Legislative and Regulatory requirements, the questions posed can be
better answered. As stated, earlier UCBs being under a dual control not all regulatory
requirements of RBI, especially those dealing with Corporate Governance vis-à-vis the Board
of Directors and Key Managerial personnel were applicable. Furthermore, though the
Banking Business of UCBs is regulated by RBI, the Directions issued by it in respect of
UCBs differ from those issued to Commercial Banks. In most instances, these Directions are
not as stringent as those for Commercial Banks. So basically, even though a framework is
provided, not much stress is laid on compliance. The inspections and audits that UCBs are
subject to are not as rigorous as those of Commercial Banks. One reason for this may be that
UCBs do not have as large a presence as Commercial Banks.

In the instant case, PMC Bank‘s management grossly flouted the norms laid down by RBI,
the MD and CEO of the Bank used his official position, knowledge of the procedures
followed by RBI inspectors and the Bank‘s internal policies, to perpetrate the fraud.
According to Mr. Bhoria, the fraud resulted due to inadequate internal controls, poor
273
Reserve Bank of India. 2015. "Maximum Limit on advances-Limits on credit exposure to individuals /Group
of borrowers-UCBs." April 15. Accessed June 9, 2020.
https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=2196&Mode=0.
274
Reserve Bank of India. 2015. "Master Circular- Income Recognition, Asset Classification, Provisioning and
Other Related Matters – UCBs." July 1. Accessed June 9, 2020.
https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9850.
275
Reserve Bank of India. 2016. "Master Direction - Know Your Customer (KYC) Direction, ." February 2015.
Accessed July2020 7. https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11261.
151
standards of Corporate Governance as the same were not under the purview of RBI. He
further added that the Board of Directors and Committees of Cooperative Banks are elected
by the Members thereby needing to please the Members. This, many a times, lands the
Cooperative Banks in trouble due to bad decisions.276

Moreover, these Board Members are not necessarily equipped with financial knowledge or
the working of the Banking System. To address the issue of the Board Members qualification
and competence, RBI had issued draft guidelines to UCBs in 2018 for the establishment of a
Board of Management, with the final guidelines being issued in December 2019, much after
the PMC Bank fiasco.

Cooperative Banks are a key component of the Banking System in India, as they provide
Banking Services to the unbanked and the underbanked. However, due to the size of their
business and their customer base, they lack the capital for investments in upgradation of their
systems, training of their staff etc. This results in Cooperative Banks facing various financial
problems, as seen in the case of PMC Bank, where at least on two occasions it was on the
brink of closure and was bailed out by HDIL.

Nonetheless, the case also highlights that bank employees, especially higher management can
and do abuse their position to commit fraudulent activities, which are detrimental to the
interests of the depositors. The PMC Bank Fraud also emphasises the need for strengthening
the regulation of Cooperative Banks in India.

4.4 YES BANK CRISIS- A CASE OF BAD BUSINESS DECISIONS OR

FRAUD

In 2003, YES Bank was incorporated as a Public Limited Company with Mr. Rana Kapoor,
Late Mr. Ashok Kapur and Rabobank International Holding as Promoters of the Company,
holding 49% of Equity therein. The Bank was granted a License by RBI to commence
Banking Business in India277 in 2004. In 2005, it entered Retail Banking in partnership with
MasterCard International with the introduction of its Gold and Silver Debit cards and also

276
Joel Rebello, Gayatri Nayak. 2019. The collapse of PMC exposes the fault lines in the financial system.
Newspaper, ET Bureau. Accessed September 25, 2020.
https://economictimes.indiatimes.com//industry/banking/finance/banking/the-collapse-of-pmc-exposes-the-
fault-lines-in-the-financial-system
/articleshow/71402139.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst.
277
Economic Times. ―Company History-YES Bank Ltd.‖ economictimes.indiatimes.com. Accessed November
2, 2021. https://economictimes.indiatimes.com/yes-bank-ltd/infocompanyhistory/companyid-16552.cms.
152
came out with an Initial Public Offering of its shares in the same year. 278 The Bank operates
in the areas of Corporate and Institutional Banking, Retail Banking and Investment Banking.

Within three years of its commencement of Banking Business, YES Bank was ranked as the
number one Bank by the Business Today-KPMG Best Banks Annual Survey 2008, in the
category of the fastest growing small banks.279 That same year, Mr. Ashok Kapur‘s life ended
tragically during the 26/11 Mumbai attacks, and Mr. Rana Kapoor who was the MD and CEO
of the bank, took complete charge of the Bank and the Board Of Directors. Under his
leadership, Yes Bank targeted mostly sectors like pharmaceuticals, real estate, electricals,
renewable energy and media and worked on building its corporate lending segment.

Mr. Kapoor took a bold approach in developing the loans division by focusing on lending to
the Corporate Sector instead of retail customers. Retail customers are small borrowers in
comparison to corporates and growing its retail loan portfolio requires any bank to build a
large network of its branches. On the other hand, a single corporate borrower can boost the
loan portfolio with just one big loan. However, it is less risky as compared to corporate
lending, where one default can lead to huge losses.280 The economic slowdown of 2008-2009,
when almost all major banks were not offering new loans to certain sectors or promoters,
YES Bank was lending capital to businesses that were in trouble and became the banker to
businesses that could not secure a loan from other banks or financial institutions.

While lending to these troubled corporates, Mr. Kapoor would charge a high fee, ranging
anywhere from 2-10% of the amount sanctioned, with interest rates that were higher than the
rates charged by his competitors. In addition, the interest on the amount sanctioned was
collected upfront in some instances, thereby securing the Bank‘s exposure to some extent.

On 5th March 2020, RBI announced that it had superseded the Board of Directors of YES
Bank and imposed a 30 day moratorium281 on the Bank, owing to the Bank‘s poor financial

278
Ibid
279
Business Today-KPMG. 2008. ―The 14th Business Today-KPMG survey of India’s Best Banks .‖
www.businesstoday.in. 06 February. Accessed November 5, 2021.
https://www.businesstoday.in/magazine/cover-story/story/indias-best-banks-129801-2008-02-06.
280
George Mathew, Sunny Verma , Sandeep Singh. 2020. Bank, Boom, Bust. Newspaper, The Indian Express.
Accessed November 6, 2021. https://indianexpress.com/article/india/yes-bank-crisis-rana-kapoor-npa-rbi-
reserve-bank-of-india-6314627/.
281
A moratorium is a temporary suspension of an activity until future consideration warrants lifting the
suspension, such as if and when the issues that led to moratorium have been resolved. A moratorium may be
153
condition and appointed the then Chief Financial Officer and Deputy Managing Director of
State Bank of India, Mr. Prashant Kumar as the Administrator.282 The Bank‘s financial health
had been declining since 2018, mainly due to its failure to attract investors, to deal with the
losses from NPAs and consequent downgrade by credit rating agencies. This downgrade
prompted the existing investors to invoke their bond covenants and closure of accounts by
depositors. Besides the deteriorating financial health, there were serious failures of corporate
governance norms.283

The troubles at YES Bank began in 2015, when the first red flag regarding YES Bank‘s asset
quality was raised by UBS, a Financial Services Company, which reported that YES Bank‘s
loans to companies that were not likely to repay the same were greater than its net worth. 284
However, these were refuted by the Bank and it complained to the Securities Exchange Board
of India(SEBI), the market regulator. The red flag was ignored by all and the Bank continued
to grow its business, with its stock prices continuously rising. The Asset Quality
Review(AQR)285 of YES Bank revealed that the Bank had concealed its NPAs, which
according to Reports had been underreported by ―over Rs 4,000 crore in Financial Year
2016, Rs 6,355 crore in Financial Year 2017 and Rs 2,299 crore in Financial Year 2018-19,
as well as cooked up its balance sheets.‖286

The first AQR, which was carried out in 2017 for the financial year, had revealed the
divergence by Yes Bank, whereby the NPAs, as classified by RBI stood, at 5 times higher
than those reported by the Bank, yet no serious action against the Bank was initiated except a
warning. By 2018-19, the situation had become alarming and Mr. Rana Kapoor was asked to
step down as the MD and CEO of the Bank and RBI replaced him with Mr. Ravneet Gill as

imposed by a government, by regulators, or by a business. Moratoriums are often imposed in response to

temporary financial hardships.
282
Gupta, Kanishka. 2020. New Delhi YES Bank stock crash and financial mess: How the crisis unfolded in 2
years. Newspaper, New Delhi: Business Standard. Accessed November 7, 2021. https://www.business-
standard.com/podcast/companies/yes-bank-stock-crash-and-financial-mess-how-the-crisis-unfolded-in-2-years-
120030600886_1.html.
283
Sood, Jyotika. 2020. RBI Imposes Moratorium On Yes Bank: All You Need to Know. News Story, Outlook.
Accessed November 7, 2021. Outlook https://www.outlookindia.com/website/story/business-news-rbi-places-
moratorium-on-yes-bank-withdrawal-all-you-need-to-know/348340.
284
Misra, Udit. 2020. Explained: How Yes Bank ran into crisis. Newspaper, New Delhi: The Indian express.
Accessed November 7, 2021. https://indianexpress.com/article/explained/how-yes-bank-ran-into-crisis-rana-
kapoor-arrest-6307314/.
285
An AQR, is a special inspection of a bank‘s balance sheets, where most of the large borrower accounts are
inspected to check if classification is in line with prudential norms. The AQR was started in 2015 as the RBI
believed that asset classification was not being done properly and that banks were resorting to ever-greening of
accounts. Banks were postponing bad-loan classification.
286
Supra Note 262
154
the MD & CEO. However, the NPAs kept rising due to defaults by major borrowers and the
stock price of YES Bank plummeted.

To better understand the reasons behind the near failure of YES Bank, it is pertinent to
understand the Prudential Norms specified by RBI in respect of classification of assets and
provisioning of advances.

According to the Master Circular, issued by RBI in 2015, on the Prudential Norms to be
followed by Banks287:

 NPA has been defined as an asset which has ceased to generate any income and
includes any loan or advance where the principal and or interest due thereon has not
been paid or remain overdue for 90 days or more, where the loan is a term loan.
 Banks require to classify NPAs into three categories, depending on the period for
which these remain non-performing, namely:
• Substandard: Those assets which remain NPA for 12 months or less.
• Doubtful: Those assets which were categorized Substandard for 12 months.
• Loss: Those assets which have been identified by the bank, or auditors
(internal or external), or RBI inspection, as nonrecoverable, but the value has
not been written off.
 Banks further need to make provisions for NPA based on the above classification. The
Loss assets must be written off, but if they remain on the books, then 100% provision
must be made in respect of these. In case of Doubtful assets, 100% provision to the
extent the security does not cover the loan and in respect of the portion covered by the
security, depending upon the time the asset remained Doubtful, the provision may
range from 25-100%. In case of Substandard assets, the banks need to make a general
provision of 15%.
 Banks to maintain a Provision Coverage Ratio288 of not less than 70%

287
Reserve Bank of India. 2015. "Master Circular - Prudential norms on Income Recognition, Asset
Classification and Provisioning pertaining to Advances." July 1.
Accessed March 6, 2021. https://m.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=9908 .
288
Provisioning Coverage Ratio is essentially the ratio of provisioning to gross non-performing assets and
indicates the extent of funds a bank has kept aside to cover loan losses.
155
 The major reasons which led to the Yes Bank crisis are:

 Risky Business Strategy: The strategy adopted by Mr. Rana Kapoor to grow the
business was risky and inadequate provisions to mitigate the risks was one of the
primary reasons that ultimately led to the crisis. Aggressive corporate lending, to
already stressed companies, though produced high returns in terms of higher interest
rates and fee, also increased the risk of these loans turning NPA.
Underreported NPAs: The AQR revealed that the Bank had been underreporting its
NPAs since Financial Year 2016-17. This Underreporting basically showed a skewed
picture of the Bank‘s balance sheets, inflating its profits. Moreover, as red flagged by
UBS, YES Bank had given loans more than its net worth to companies which were
unlikely to repay the amount in a limited time. According to one Newspaper Report,
―One of the reasons for Yes Bank’s troubles was the massive increase in its loan book
between 2014 and 2019. From total advances of Rs 55,633 crore in 2014, the number
grew nearly five times to Rs 2,41,500 crore in 2019 — a CAGR or compounded
annual growth rate of 34.1 per cent, as compared to roughly 10-12 per cent for other
lenders.‖289 Big defaulter companies included DHFL, IF&FS, Reliance Group of
Industries, Cox & Kings, Café Coffee Day, CG Power, Essel Group, Essar Power
amongst others.
 Provision Coverage Ratio, as required by the Prudential Norms, was not maintained
by the Bank. With defaults on loan repayments piling, and the financial health of the
Bank deteriorating, the Bank did not make adequate provisions from the profits and
its Provision Coverage Ratio, during the Financial Year 2019-20, fell to 43.1%.290
 Ever-greening of Loans: Besides Underreporting, there were allegations that the
Bank was hiding its NPAs through ‗ever greening of the loans, whereby YES Bank
arranged for stop-gap loans from other entities in case the borrower was about to
default on the repayments. 291
This arrangement worked as a temporary measure to postpone the inevitable, and
when many of its borrowers like DHFL, Reliance Group of Industries, IL&FS, being
some of the biggest, failed, the Bank‘s NPAs rose sharply. With inadequate
provisioning and securities, the losses sustained mounted.

289
Supra Note 259
290
Gopakumar, Gopika. 2020. Yes Bank posts record ₹18, 564-cr loss in December quarter. Newspaper,
livemint.com. Accessed March 7, 2021. https://www.livemint.com/companies/company-results/yes-bank-posts-
record-rs-18-564-cr-loss-in-december-quarter-11584209681050.html
291
Supra Note 259
156
  Declining Financial Health: With large number of depositors closing their accounts
and investors pulling out, the Bank‘s financial health deteriorated with its loan books
which stood at Rs 2.24 lakh crores, being greater than its deposit books, which by the
end of September 2019 stood at Rs 2.09 lakh crores.292 Even after the exit of Mr.
Kapoor, the Bank was unable to get new investors or raise capital.
 Poor Corporate Governance and Internal Controls: There were allegations of non-
compliance of Corporate Governance norms, especially regarding conflict of interest
related to some transactions in which Mr. Kapoor had been part of the decision
making.
Allegations were made by a whistleblower, in 2018, regarding the Bank‘s deliberate
Underreporting and misclassification of its NPAs during the period 2008-2018. The
whistleblower also alleged that not all transactions were at arm‘s length as required by
Corporate Governance norms in respect of related party transactions. Though an
internal inquiry was constituted to investigate the matter, the results were
inconclusive.293 According to some, Mr. Kapoor took all major decisions, with most
of the Board Members being pliant.294 Even the CBI chargesheet against Mr. Rana
Kapoor alleges that he took ―undue personal interest‖ in investments in DHFL that
were risky and also did not pay heed to the warnings from the Bank‘s Risk
Management Committee and Treasury.295 Internal audits that a bank is required to
carry out periodically, coupled with the requirement of an Independent Audit
Committee, comprising of Independent Directors, besides the Risk Management
Committee, all failed to highlight and or report the anomalies and malpractices being
followed, pointing to weak or non-existent internal controls.
 Poor Regulatory Control: Despite the warnings and red flags, RBI did not take any
actions against the Bank or its management. As early as 2017, when the divergence in
NPAs was revealed by the AQR, RBI was aware of the Underreporting, which

292
Singh, Sandeep. 2020. 44 companies from 10 big groups account for Rs 34,000-crore Yes Bank bad loans.
Newspaper, New Delhi: The Indian Express.
Accessed March 10, 2021. https://indianexpress.com/article/business/banking-and-finance/yes-bank-crisis-rana-
kapoor-arrested-bad-loans-6307485/.
293
Shakeb Akhtar, Mahfooz Alam and Mohd Mohsin Khan. 2021. "YES Bank Fiasco: Arrogance or
Negligence." (SAGE Open). Accessed January 5, 2022. doi:10.1177/25166042211061003 2021.
294
Rai, Vinod. 2020. "Lessons from the Yes Bank Saga in India." ISAS Insights. Accessed April 7, 2021.
https://www.academia.edu/43700088/Lessons_from_the_Yes_Bank_Saga_in_India.
295
Chauhan, Neeraj. 2021. Rana Kapoor ignored warnings by Yes Bank’s risk, treasury teams. Newspaper,
Livemint.com. Accessed December 6 , 2021. https://www.livemint.com/industry/banking/rana-kapoor-ignored-
warnings-by-yes-bank-s-risk-treasury-teams-11631040409652.html.
157
 ironically continued for another 2 years before RBI acted and asked Mr. Kapoor to
step down as the MD and CEO. Even the Nominee Director, placed on the Board of
YES Bank, failed to raise concerns with regard to the continued financial breakdown
of the Bank. The YES Bank failure and fraud was described by Bloomberg as a
failure in ―slow motion in full view of authorities.‖296

The above reasons may point towards a scenario that the troubles at YES Bank were only bad
business decisions with no mala fides. However, a few days after RBI put the Bank under
moratorium, ED arrested Mr. Rana Kapoor under the PMLA, on charges of laundering
money. The chargesheet filed by ED alleged that out of the total loans sanctioned by YES
Bank during the tenure of Mr. Kapoor, Rs. 20,000 crores worth of those loans had become
NPAs.297 The ED further alleged that Mr. Kapoor had received Rs. 5,050 crores as bribes for
sanctioning these loans, besides misusing his office, forming shell companies to launder
money and other irregularities in sanctioning loans.298

A case was registered by CBI, on 7 March 2020 against Mr. Kapoor under suspicion of fraud,
cheating and criminal conspiracy in the disbursement of loans to DHFL and its promoters.
CBI filed its chargesheet in June 2020 against Mr. Kapoor and 11 other people including
DHFL, its promoters, Mr. Kapoor‘s daughters, owners of DoIT Urban Ventures Ltd. as
accused in the fraud that led to the YES Bank failure.299

The case of both ED and CBI was that Mr. Kapoor and his family received monetary benefits
of Rs. 600 crores, from DHFL, for extending credit through YES Bank in the form of
investments of Rs. 3,700 crores in short term debentures of DHFL, which was facing
financial crunch.300 This amount of Rs. 600 crores was advanced as a loan by DHFL to DoIT
Urban Ventures Ltd., owned by Kapoor‘s daughter.

The cases against Mr. Kapoor and others are sub-judice, however from the details of the YES
Bank failure, it is clear that poor Governance standards and internal controls in banks can

296
Mukherjee, Andy. 2020. India Can Use Yes Bank Debacle to Chase China in Crypto. Newspaper,
Bloomberg. Accessed October 7 , 2021. https://www.bloombergquint.com/global-economics/india-can-use-the-
yes-bank-debacle-to-chase-china-in-crypto.
297
Supra Note 259
298
Choudhary, Shrimi. 2020. YES Bank loan fraud: CBI charges Rana Kapoor with criminal conspiracy.
Newspaper, Business Standard.com. Accessed December 7, 2021.
https://www.business-standard.com/article/current-affairs/yes-bank-loan-fraud-cbi-charges-rana-kapoor-with-
criminal-conspiracy-120062501509_1.html.
299
Ibid
300
Ibid
158
lead to disastrous results for the investors and depositors and the Banking Sector as a whole.
The confidence of people in the Banking Sector took a serious hit, with most banks‘ share
prices seeing a decline after the news of the moratorium placed on YES Bank.

4.5 ABG SHIPYARD: UNFOLDING OF INDIA’S BIGGEST BANK

FRAUD*

Four years after the PNB- Nirav Modi case hit the headlines, news of a bank fraud amounting
to a whopping Rs. 22, 482 crores, nearly double that of involved in the former case, made
headlines and once again cast doubts, in the minds of depositors, about the integrity of the
Banking Sector. The fraud according to reports involves 28 Banks, who had extended credit
to the Company as a Consortium of Lenders, with ICICI Bank being the lead bank.

ABG Shipyard Ltd.(ABG SL) was incorporated in 1985 by the ABG Group as a shipbuilding
and repairing enterprise, located in Gujarat, India. It went on to become one of India‘s largest
shipbuilders with customers from across the globe.301

The fraud was discovered, when State Bank of India, one of the lender banks, filed a
complaint with the CBI, based on a forensic audit report by Ernst & Young LLP. ABG SL‘s
troubles started with the global financial crisis of 2008-09, due to which there was a
worldwide fall in demand of goods and a consequent fall in international trade, affecting the
shipping business. This led to a fall in the demand for ships and cancellation of orders,
thereby putting a strain on ABG SL‘s finances. In 2013, ABG SL‘s account was declared as
NPA but was later reconstructed under the Corporate Debt Restructuring Scheme. However,
the Shipping Industry, worldwide, was facing severe recession and ABG SL was unable to
get any new orders. The Company was unable to meet the milestones that had been
envisioned at the time of restructuring of the loan and once again defaulted in repayment of
its interest on the loans.

As part of auditing requirements, ABG SL‘s account was audited and, in 2016, the Auditor‘s
Report pointed to several lapses of the Company in the utilization of the funds disbursed by
the banks. Based on the Auditor‘s Report, ABG SL account was once again declared as NPA

*
The Case was reported in February 2022, just as the Researcher was in the process of submitting the Thesis.
Since investigations are still ongoing, only the facts known so far are being discussed.
301
Goodreturns. "ABG Shipyard Ltd. Company History and Annual Growth Details." goodreturns.in. Accessed
February 25, 2022. https://www.goodreturns.in/company/abg-shipyard/history.html.

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in 2016 and a Forensic Audit was initiated in 2018. The forensic audit, which was carried out
by Ernst & Young LLP, pertained to the years starting from 2012 upto 2017.302 Meanwhile
ICICI Bank Ltd., the lead Bank, referred the matter to NCLT for the commencement of
Corporate Insolvency Resolution Process.

According to newspaper reports , the complaint filed by SBI(being the largest Public Sector
Bank of the Consortium) in 2020 with CBI, stated that the report of the Forensic Auditors
found that ABG SL had not only diverted the funds to other entities but had also
misappropriated the same. According to the Auditor‘s Report, ―the funds were allegedly used
for unstated purposes, investments were made through a Singapore-based subsidiary and
there were pay-outs running into hundreds of crores to related parties. Properties were also
bought from the funds provided by ABG Shipyard.‖ 303

On the basis of the complaint, CBI after carrying out initial verification of facts and issues,
registered an FIR, in February 2022, against ABG SL and its Chairman & MD Mr. Rishi
Kamlesh Agarwal and other Directors of the Company for criminal breach of trust,
misappropriation and diversion of funds.

Several questions are being raised, regarding the delay in filing the complaint by the
consortium and then a further delay by CBI in registering the FIR. More questions are bound
to come up regarding the role of the Consortium of banks and auditors, as large loan accounts
are regularly audited, and the fraud should have been uncovered much before the accounts
turned NPA.

Even though the present fraud is one primarily perpetrated by the customer on the Bank, it
still raises questions with regard to internal controls and the vulnerabilities the current
banking system has presented in detecting and preventing such huge frauds from happening.

302
Business Today . 2022. ―CBI on how the ABG Shipyard fraud unfolded .‖ businesstoday.in. 16 February.
Accessed February 25, 2022. https://www.businesstoday.in/latest/economy/story/cbi-on-how-the-abg-shipyard-
fraud-unfolded-322759-2022-02-16.
303
The Hindu. 2022 . ―CBI books ABG Shipyard and others for allegedly causing ₹22,842-crore loss to banks
.‖ thehindu.com. 12 February . Accessed February 25, 2022 . https://www.thehindu.com/news/cities/Delhi/cbi-
books-abg-in-biggest-bank-fraud-case-of-more-than-22842-crore/article38418609.ece.
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4.6 CONCLUSION

The above case studies are just the tip of the iceberg and only representative of the rot that
goes much deeper. In four years starting 2018 till 2022, the total exposure of banks due to
these frauds stands at approximately Rs 61,000 crores. No doubt that some of this money will
be recovered by the banks, but does that solve the issue or absolve the responsibility of the
banks from preventing such incidents from happening?

Insiders, especially those belonging to the upper management or those who have special
privileges due to the nature of their jobs, can wreak havoc as seen from the above case
studies. Greed, opportunity and the absence of stringent actions are a potent mixture, which
provide the right impetus for the unscrupulous to continue committing fraudulent activities.
Frauds in the Banking Sector cannot be completely eliminated, however, internal frauds can
definitely be controlled and curbed, if internal controls, governance and oversight are
strengthened by the banks and the legislations provide for the requisite deterrence.

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