How a diamond king "made it in India" - and got caught

Published by MAC on 2018-02-24
Source: Countercurrents

London Calling exposes a gem of a scandal

The Nirav Modi scandal simplified

Ashish Singh

Countercurrents

18 February 2018

It has been several years since I used the phrase “shameless audacity”,
but somehow I feel compelled to use it again and again to describe the
saga of this newer Modi: and here everything is personal.

The reason is: in a country of 1.2 billion people the majority struggles
to have access to basic amenities to survive the day-to-chaos and
challenges, and then we meet and see these characters, rather filthy ones,
who were born on the back seat of Audi and could simply rip us off (in
this case one of the biggest nationalised banks in India with over 80
million customers, 6,937 branches, and 10681 ATMs across 764 cities).

It is personal because at present (and most likely in future as well) we
don’t know who will pay the price. Mallya lives abroad, Lalit is out
there, and now Nirav and Mehul. Who says earning money is bad, work hard
or be smart and earn; don’t just rob us. Then it becomes personal. It is
personal because people like me have to roam around bank branches just to
understand the technicalities, and you guys suddenly find a way out (of
the country with the money of all of us).

During my college days back in Tata Institute of Social Sciences, Mumbai
we had several discussions about “Banker to the poor” and how banks should
reach out to people: Banking and Microfinance being one of the subjects;
it is around that time when investment banking took a fall and Lehman
Brothers could not sustain any longer. Slowly we got into jobs and higher
studies and those discussions became limited to our occasional
conversations, and now they take space on social media. For this article,
I am using various message and posts written by different Indians and
non-Indians (including media houses). I don’t wish to have any copyright
for any material presented in this article.

Who is Nirav Modi:

Forbes profiled him:

Indian-born diamond jewelry designer Nirav Modi is the founder of the
$2.3 billion (revenues) Firestar Diamond.
Modi grew up in Belgium, dropped out of Wharton and moved to India
where he got trained in the diamond trade under his uncle.
He went on to launch his own Nirav Modi brand with 16 stores in
locations such as Delhi, Mumbai, New York, Hong Kong, London and
Macau.

As per NDTV:

In 1999, Nirav Modi set up a diamond sourcing and trading company
called Firestar Diamond. The company is worth $2.3 billion today.
Brand Nirav Modi debuted with a pair of earrings that the billionaire
designed for his friend in 2008.
Nirav Modi has a long list of star clients – Kate Winslet, Steven
Spielberg, Sharon Stone and Aishwarya Rai to name a few.
Donald Trump, now US President, inaugurated his first store in New
York’s Madison Avenue in 2015.
Last year, Priyanka Chopra, who scored Hollywood success with her hit
series Quantico, was roped in as the brand’s global ambassador.
Nirav Modi has jewelry boutiques across three continents – in London,
New York, Las Vegas, Hawai, Singapore, Beijing and Macau. In India,
Nirav Modi has his stores in Mumbai and Delhi.

And he is now one of the primary accused of an ongoing investigation where
the CBI is acting on a complaint from the Punjab National Bank, a state
banking institution, that alleges Modi and his partners defrauded the bank
for ₹280 Crore (approximately USD 40 million) by conspired with bank
officials to fraudulently obtain Letters of Undertaking for making
payments to overseas suppliers.

Should we talk about the poor quality of roads, problems related to access
to quality healthcare, literacy rate, unemployment, caste-class issues
among other things to explain the gravity of the situation? Well, probably
we don’t need to. Dude, “did us” and is likely that he will never call
back.

First, The Concept

Let’s understand how things work.

Some importer, let’s call him Nirav Modi or NM, wants to import pearls or
diamonds and then sell them. The purchase requires money, so NM approaches
a bank, say Punjab National Bank (PNB).

PNB says look, I’ll give you a loan but it will be like at 10%.

NM thinks hard and says, no, that’s too much. Wait, why don’t I take a
foreign currency loan instead, after all I’m buying in dollars? Much lower
interest rates no? I can get at LIBOR+2% and LIBOR is like 1.5% so I’ll
have the money at 3.5%!

But who will give NM a foreign currency loan? A bank abroad? They don’t
know NM. They don’t have any history of NM, so why will they give him
money?

SO NM goes to PNB and says, boss, you’re my banker, so please help some
foreign bank give me some money to buy diamonds. Say that you will
guarantee my loan by giving me a “Letter of Undertaking” (LOU).

PNB now should be saying look, if you want me to give Rs. 100 cr.
guarantee, you give me stuff worth 110 cr. at least. As collateral.

But PNB, for some strange reason, doesn’t ask for collateral. More on that
later.

So now the foreign bank is ready to lend NM the money. Because PNB will
guarantee it. And the foreign bank trusts PNB. Why does it trust PNB?

Because PNB sends a message on SWIFT – the banking message service – that
PNB guarantees Rs. 100 cr. of money for 180 days for Mr. NM at an interest
rate of, say, LIBOR + 2%. It’s like a message – written in stone,
effectively – that says PNB will pay if NM doesn’t pay.

In fact the foreign bank trusts only PNB. So it gives the money to PNBs
account with it, called by PNB as a “Nostro” – the account that PNB
maintains with banks abroad, where the other bank will send money meant
for PNB customers.

PNB’s nostro account gets the money.

PNB then gives NM the money from the Nostro account, usually paid off to
whoever NM is buying his diamonds from. This payment is to someone outside
India usually, to fund a purchase of diamonds or whatever.

Note this carefully: The other bank gives money to PNB’s Nostro account.
Not to NM. They don’t care about NM. They only know that PNB has given a
guarantee on the SWIFT channel.

Note: the other bank is nowadays mostly the foreign branches of Indian
banks. Because the phoren banks have realized something sinister – that
PNB’s guarantee is a strange beast that isn’t backed with much, but we’ll
come to that

The foreign bank couldn’t care less about whether NM was buying diamonds
or bitcoin – to them, PNB would pay back even if NM’s bitcoin wallet got
stolen.

Why does PNB give a guarantee? Fees. Each year, a bank may charge upto 2%
to give the LoU.

So What Happens When It’s Time To Pay Back?

NM has to get the pearls in India, sell them, receive the money and pay
PNB. On the due date written on the LoU.

Then PNB will pay back the foreign bank saying okay, we got the customer’s
money so we’re giving it back to you. With interest etc.

That’s what is supposed to happen. But in reality, things went a little
berserk, it seems.

The Reality: A Bit of a Ponzi

NM might not pay back at all. NM might use the money to speculate in the
markets. Or do something else.

What if NM in the above example simply didn’t have the money to pay back?
Instead, he asks a PNB official to open ANOTHER LoU. For the amount owed
plus interest. So if we had the first LoU at $10 million the second one is
$11 million to cover the interest on the first.

The money from the second LoU is used to repay the first. It’s just
rolling over of credit. Over and over. Standard definition of a ponzi
scheme.

This can easily balloon into a larger amount, so large that it’s too much.
In effect many such arrangements have turned into semi-ponzi schemes, with
one LoU being opened to repay another and so on.

Which is what is likely to have happened.

We don’t know the details, but it looks like:

Nirav Modi took loans from foreign branches of Indian banks through an LoU
issued by PNB

This was done through a SWIFT based LoU issued through a rogue employee
(or many of them) at PNB

The orders never showed up in the core banking system for monitoring

LoUs were rolled over all the way since 2011, and possibly increased over
time too.

The rogue official retired in 2017, and the replacement refused to roll
over the LoU which came due in Jan 2018 because he couldn’t find the past
transactions in the system

No rollover means a default, since there was no money to pay. So PNB
quickly files an FIR saying oh goodness we have lost 280 cr. on the Jan
LoUs

Then someone said, “Abeyaar, is there more of these not-in-system LoUs?
Someone check no?”

Then someone checked.

Oh gawd. 11,400 crores. or is it 60,000 crores?

That’s a lot of crores.

Everyone in the bank panicked.

Why couldn’t Nirav Modi just pay it back? He must have the original money no?

Because if it was ever intended to be paid back, the rollovers wouldn’t
have been required. At some point, things got so out of hand that
rollovers were required in order to stay current.

Typically this would not be a problem. If PNB had done things right, they
would have had collateral worth the amount of guarantee, and they would
have sold that collateral and paid the foreign bank.

But, and here’s the real issue: PNB didn’t have any collateral.

Why did PNB give a guarantee without collateral?

If you and I go for a loan to a bank, they’ll ask us for income proof, and
collateral. Only small tiny personal loans and credit card loans come
backed without collateral. For something of the order of 11,000 cr. you
would think they would ask for collateral.

Especially after the scene with Mallya where loans to Kingfisher were
given on nearly no collateral (though even there they had a house and some
promoter shares pledged)

Why did PNB give this guarantee then? It’s typical – banks give guarantees
for more the amount you give as collateral. Because business relationships
etc. And then:

Because nearly every bank is doing it.

The loan was not a “fund based limit”. In a fund based limit like a term
loan, the bank pays out money. In non-fund-based limits, the bank will
only pay if someone else defaults or an event happens – like a Bank
Guarantee or an LC or an LoU.

Meaning, PNB assumed that the foreign bank was giving a loan directly to
Nirav Modi and that PNB needed to pay only in case Nirav Modi defaulted.
So in the eyes of PNB it was always an “non-fund-based” loan.

But this is how a significant part of import financing works. They all
rollover credit, and they all use LoUs for much higher than they can offer
as collateral.

From my sources, the scale is huge. For every Rs. 100 that a bank has
collateral, they will easily provide LOUs for upto 6x the amount. This is
a real problem – that most public sector banks do not keep much collateral
against non-fund-based limits given to importing customers.

So even if a bank has collateral, it’s nowhere near enough. And then, such
unfunded liabilities are not even reported to RBI!

Basel Reporting: No Disclosure

PNB has “unfunded” exposure of 11,000 cr. they say. But they don’t even
reveal it in their latest Basel III disclosure:

The funded exposure to “Gems and Jewellery” is shown at 1860 cr.

Unfunded to the same sector: 842 cr.

This doesn’t even add up. So, in effect, PNB didn’t reveal that it was
funding massive quantities of “unfunded, contingent exposure”. They will
of course pretend that they didn’t know, because the transactions weren’t
in the core banking system.

Did Employees Hide it? Was PNB Responsible or was it a fraud?

Can employees be responsible? Could they have hidden the credit and the
rolling over of LoUs? But honestly, how does a 11,000 cr. credit pass
muster without top management realizing it?

Think of it – your nostro account with these other banks keeps getting big
credits that add up to 11,000 cr. Will you not reconcile it in the
accounting? The “why is this money even here?” question should have been
asked by someone who audits accounts, one thinks?

And the SWIFT messages. It’s a specific kind of message. Why wouldn’t PNB
audit the SWIFT trail? Reconcile it with the core banking system? How many
more such skeletons will tumble if they do?

Their excuses are

Data wasn’t entered into the core banking system. (Of course, otherwise
you would have had to report it)

LOUs weren’t authorized. (Hard to believe, because the amounts are very
large. Surely someone on the top would know?)

The SWIFT system was illegally used. (Again, hard to believe that a bank
like PNB would not audit its SWIFT messages regularly. Or its auditors. Or
RBI.)

On the face of it, it looks like the ex-employee is being used as a
scapegoat. It’s likely that a lot of people were in on this thing. And
that it generated massive, fat fees for PNB all these years.

Fees wise: Imagine 11,000 cr. worth LoUs being renewed each year – that’s
upto Rs. 200 cr. in fees that was all hitting PNB’s top line. You could
bribe an employee to maybe give you a small increase – say 10-20 cr. but
when you hit numbers like 11,000 cr. this is surely something the top
management would know.

What’s the Scale of this scam?

While PNB reported it as a 11,000 cr. scam, they filed an FIR with the CBI
for only Rs. 280 cr. This has probably expanded since then but even if the
total outstanding is as much as that, there’s a good chance that the
actual loss amount will be lesser.

All of it will be borne by PNB right now. Whether someone abused their
SWIFT usage is not relevant, if PNB’s SWIFT message said they will pay,
they have to pay if there is a default.

But think about the fallout. The problem was that some liabilities were
not in the system. There could be more such LoUs. From the same branch or
others. Other banks could have such LoUs too. It’s trivial to start
looking – and we know that Nirav Modi will not be an isolated case.

Also, the issue was that the limits had no collateral behind them. If all
banks are told to verify their non-fund-based limits and demand collateral
against them (say at least 25%) then the scale would be absolutely
massive. It’s not like this is happening only with Nirav Modi or Choksi. A
very large number of importers of commodities have been doing this, and
rotating credit. A change in regulation here can change the game
dramatically for every other bank (and import account) in the system.

The simple point: this particular transaction will result in a lower loss
than 11,000 cr. for PNB. Because of recoveries and such. But if RBI asks
all banks to pull up collateral on such lending and stop such practices,
the scale is many times larger.

What about the PNB stock?

It’s fallen 17%. But note that it already has 60,000 cr. of gross NPAs.
Another 11,000 cr. will hurt it but not kill it. It won’t die – the
government will take it over. Shareholders might suffer, but come on as a
shareholder of a public sector bank you’re used to suffering.

The problem really is: There is never just one cockroach. When you go
deeper, you are likely to find more dirty, dark secrets, and none of them
will be any good.

PNB is gonna hurt for a while, but so are others who will find their books
similarly tarnished once they investigate.

Will This Bring The Market Down?

Have you been living under a rock? Nothing will ever bring the market
down, nowadays.

But the one thing that does bring markets down is the outflow of
liquidity. What if so much of the “ponzi” credit – essentially money that
was rolled over very month – is being invested directly, or indirectly,
into stocks? If RBI tightens up, liquidity will pull money out of stocks,
and that will hurt.

Of course, this hurts the fiscal deficit since PNB has to be rescued. So
bond yields are up to 7.6% and therefore we’d avoid any long term funds or
bonds. Short term it will have to be.

But overall, we wouldn’t worry too much. Just react, don’t predict. What
would you do if stocks fell? Better to answer that than to say they will,
or they will not.

(And no, not buying PNB)

Our View: Fix it.

This is the Indian public sector banking system. Fix it.

How can you have transactions on SWIFT outside CBS? Fix it.

Why would you not reconcile the nostro accounts? Suspend the auditors.
Fire top management. Fix it.

Telgi, Harshad Mehta, Saharashree could not run away, but these guys did.
Are they simply smarter or we have just become ignorant? Oh, by saying
“we” I don’t refer to the public (who apparently should know everything,
yeas a little touch of bollywood is extremely important here, you know
Priyanka is worried!)

Do I know the solution? Yes, just fix it. Put them in prison. Take the
money back, and don’t harass or depress us anymore with some additional
burdens which we can’t afford.

“Banker to the Poor” is a story which ended with a Nobel Prize for Mohd.
Yunus, we are yet to witness what “Making Banks Poor” will do to Nirav and
his alike.

I guess I should just share another whatsapp message now:

“Ravi Subramanian ‘s fictional book (In The Name of God – Penguin) that
released last year was about a banking fraud story.

The main fraudster was a powerful jewelry trader by the name Nirav Choksi.

Nirav Choksi was India’s most exclusive jeweler whose high flying
clientele included half of Hollywood and India’s socialites.

The 2 main jewelers in the current PNB fraud story are Nirav Modi and his
mama Mehul Choksi. Nirav Modi is/ was India’s most exclusive jeweller. Is
this a coincidence??”

Ashish Kumar Singh is a Doctoral Candidate at Political Science Department
of Higher School of Economics- The National Research University, Moscow.
He can be reached at- ashish.tiss@gmail.com