LAW OF BANKING AND NEGOTIABLE INSTRUMENTS
Willful Defaulters
SUBMITTED TO,
Ms. GARIMA GOSWAMI,
ASSISTANT PROFESSOR OF LAW,
GUJARAT NATIONAL LAW UNIVERSITY.
SUBMITTED BY,
MRINMAY KUSHAL & KAVYA LAGALI
BATCH 2017-2022
REGISTRATION NUMBERS: 17A088 & 17A066
BACKGROUND
In accordance with the directions of the Central Vigilance Commission for
accumulation of data on willful defaults of Rs.25 lakhs or more by RBI and spread
to the revealing banks and FIs, a plan was confined by RBI with impact from first
April 1999 under which the banks and informed All India Financial Institutions
were required to submit to RBI the subtleties of the willful defaulters. The plan
was changed in May 2002, in view of suggestions of Working Group on willful
defaulters, which was additionally modified now and again according to the
proposals of the Committee on Data Format for Furnishing of Credit Information
to Credit Information Companies and different criticisms got from various
partners.
INTRODUCTION
A 'willful default' would be regarded to have happened if any of the accompanying
occasions is noted:
The unit has defaulted in gathering its installment/reimbursement commitments to the
moneylender notwithstanding when it has the ability to respect the said commitments.
The unit has defaulted in gathering its installment/reimbursement commitments to the
moneylender and has not used the account from the loan specialist for the particular
purposes for which account was benefited of yet has occupied the assets for different
purposes.
The unit has defaulted in gathering its installment/reimbursement commitments to the
moneylender and has redirected the assets so the assets have not been used for the
particular reason for which account was profited of, nor are the assets accessible with
the unit as different resources.
The unit has defaulted in gathering its installment/reimbursement commitments to the
moneylender and has likewise arranged off or expelled the portable fixed resources or
unflinching property given to verify a term advance without the learning of the
bank/loan specialist.
FACTORS CONTRIBUTING TOWARDS THE RISE OF NPA’S
Standard obligation contract determines in addition to other things, the borrower's
guarantee to offer a reimbursement of credits steady over states, with the bank being
permitted to seize the entire income when the reimbursement can't be ensured. The
majority of the obligation contracts are portrayed by asymmetric data between the loan
specialist and the borrower which is believed to be the way in to the determined issue of
credit default and the subsequent collection of NPAs in a critical position sheet of banks.
With regards to obligation contract, it may emerge, as a rule, for two reasons.
a. First, it might emerge in light of the fact that borrowers who take out advances from
the bank for the most part have much preferred data over the moneylender about the
potential hazard and return related with the venture that the borrower intends to
attempt.
b. Second, if the genuine income created from the venture task is the private data just of
the borrower, at that point default may emerge
The borrowing unit may default ‘willfully’ for several reasons such as deliberate non-
payment of dues despite adequate cash flow, underreporting of cash flow, diversion of
funds, siphoning off funds etc. Whatever be the reason, when willful default occurs, this
highlights the fact that direct truth revelation does not work in equilibrium debt contract.
The literature on costly state verification claims that this kind of moral hazard problem
can be solved if the lender can commit to verify ex-post the borrowers’ cash flow and/or
if the agents can contractually agree on large penalties for those borrowers who
strategically default on their debt. In particular, with infinite penalties, the first-best may
be achieved. Intuitively, very large penalties provide the right incentive for borrowers to
report their financial situation truthfully to the creditor, even if the latter audits only with
a very small probability. Consequently, the asymmetric information can be eliminated at
a cost, which tends to zero as the audit probability becomes sufficiently small (Becker,
1968). Thus it is easy to prevent untruthful reporting in the auditing zone and, therefore,
truthful reporting need not be rewarded.
Nonetheless, after the reality models, most existing models consider an exogenous
furthest point of confinement to the punishment that can be forced to defaulters (see
Townsend, 1979; Mookerjee and Png, 1989; Border what's more, Sobel, 1987) or expect
that there is limited obligation with respect to the borrower (Storm and Hellwig, 1985).
Townsend (1979) and Gale and Hellwig (1985) demonstrate that debt contract might be
intended to such an extent that it fulfills the motivating force similarity requirements
what's more, reality disclosure of the borrower's income is the predominant system and,
along these lines, standard obligation contract seems, by all accounts, to be the ideal
contract from the effectiveness point of view. Interestingly, in this examination of willful
default, standard obligation contract doesn't have all the earmarks of being ideal contract
thus, in balance there exists a positive amount of willful default. First, if a probability
structure is attached to the principle of auditing, it may not be possible to identify a
threshold bankruptcy point as in standard non-random costly verification models. It is
true that there exists some cash flows reported by the borrower that are always audited
with probability one. Be that as it may, in such cases, it is likewise consistently gainful to
decrease these probabilities that would carefully lessen the normal expense of auditing
without influencing the motivator similarity states of the debt contract. Subsequently any
instrument with sure likelihood of inspecting now and again would be problematic.
Second, in non-arbitrary examining methodology of Townsend (1979) and Gale and
Hellwig (1985), untruthful revealing of income is exceptionally punished and honest
detailing isn't punished in any way.
Accordingly, it is anything but difficult to forestall misrepresentation of reports in the
evaluating zone and the borrower need not be remunerated for honest revealing.
Notwithstanding, under stochastic check conspire, if the borrower is rewarded for truthful
reporting rather than not punished whenever the probability of auditing is less than one,
the threshold bankruptcy point in the sense of standard models does not exist
(Mookherjee what's more, Png, 1989). Third, our structure contrasts from Gale and
Hellwig (1985) in another regard. If there should be an occurrence of Gale and Hellwig
(1985), the reimbursement capacity is fundamentally steady in the no audit zone on the
grounds that generally the borrower could cheat by reporting a message of income that
relates to the base reimbursement in the no-audit zone. This makes the debt contract
motivation perfect in standard models. Be that as it may, in our examination of willful
default, repayment capacity isn't really steady over states. This happens in light of the fact
that here auditing happens with some probablity. On the off chance that there is
evaluating and it is discovered that there is untruthful announcing of the real income
position, the borrower must compensation a punishment. Ideal repayment to the chief is a
component of the detailed salary returns, given that the likelihood of auditing is
everywhere lower than one.
As a result, since in the optimal incentive scheme , the likelihood that the report won't be
reviewed effectively is sure, the specialist won't pay a consistent move over all conditions
of dissolvability. In developing nations, notwithstanding anything willful default happens
at the equilibrium as (1) the information to confirm and cross check the real income is
inaccessible. (2) auditing is expensive and along these lines irregular; and (3) discipline is
slacked because of wasteful legitimate framework. Additionally, it may not be anything
but difficult to avoid untruthful reportinin the inspecting zone if the borrower intrigues
with the interior reviewer of the bank so the examiner doesn't really review the
borrower's genuine income position. In this paper,we consider irregular i.e random
auditing system pursued by the manages an account with duty. Thus, willful default
shows up at the harmony. We pursue this model so as to demonstrate the tradeoff among
default and benefit guideline of banks.
Highlighting the incidence of 'willful default' in developing nation banking frameworks,
for example, India, where the borrowing unit underreports its actual monetary position
and defaults willfully. We develop a successive game to address this issue. Given the
above measure of willful default and the borrower's goal to amplify his benefit, we
demonstrate that willful default happens in balance due to underreporting of its genuine
income. We additionally investigate the connection between the benefit of a bank and the
measure of determined default that happens at the balance resulting on the advance
progression process. We contend that there is a trade off between the two. This features
the dilemma in the goal of the controller whether to control the degree of willful default
in this manner permitting a fall in the benefit of the bank or to enable the bank to build its
benefit alongside the mounting weight of NPAs because of stiff-necked default.
WILLFUL DEFAULT AS A TYPICAL PROBLEM OF
DEVELOPING COUNTRY FINANCIAL SYSTEM
The Global Financial Stability Report (GFSR) is a semiannual report by
the International monetary fund (IMF) that assesses the stability of global financial
markets and emerging-market financing. It is released twice per year, in April and
October. The GFSR focuses on current conditions, especially financial and
structural imbalances, that could risk an upset in global financial stability and
access to financing by emerging-market countries. It emphasizes the ramifications
of financial and economic imbalances that are highlighted in one of the IMF's other
publications, the World economic outlook. Topics covered in the GFSR usually
include systemic risk assessments in worldwide financial markets, worldwide debt
management, emerging economic markets and current economic crises that could
affect finances worldwide.
The April 2019 Global Financial Stability Report (GFSR) finds that despite
significant variability over the past two quarters, financial conditions remain
accommodative. As a result, financial vulnerabilities have continued to build in the
sovereign, corporate, and nonbank financial sectors in several systemically
important countries, leading to elevated medium-term risks. The report attempts to
provide a comprehensive assessment of these vulnerabilities while focusing
specifically on corporate sector debt in advanced economies, the sovereign-
financial sector nexus in the euro area, China's financial imbalances, volatile
portfolio flows to emerging markets, and downside risks to the housing market.
These vulnerabilities require action by policymakers, including through the clear
communication of any changes in their monetary policy outlook, the deployment
and expansion of macroprudential tools, the stepping up of measures to repair
public and private sector balance sheets, and the strengthening of emerging market
resilience to foreign portfolio outflows. This GFSR also takes an in depth look at
house prices at risk, a measure of downside risks to future house price growth-
using theory, insights from past analyses, and new statistical techniques applied to
32 advanced and emerging market economies and major cities. The chapter finds
that lower house price momentum, overvaluation, excessive credit growth, and
tighter financial conditions predict heightened downside risks to house prices up to
three years ahead. The measure of house prices at risk helps forecast downside
risks to GDP growth and adds to early-warning models for financial crises.
Policymakers can use estimates of house prices at risk to complement other
surveillance indicators of housing market vulnerabilities and guide
macroprudential policy actions aimed at building buffers and reducing
vulnerabilities. Downside risks to house prices could also be relevant for monetary
policymakers when forming their views on the downside risks to the economic and
inflation outlook. Authorities considering measures to manage capital flows might
also find such information useful when a surge in capital inflows increases
downside risks to house prices and when other policy options are limited.
Based on the 2004 report it was evident that the problem of nonperforming loans is
much more severein the developing countries of the world compared to their
developed counterpart. As
Allen and Gale (2004) compare the financial systems of the developed vis-à-vis the
developing countries, they point out that the two systems differ as the former
depends more on the financial markets and less on the banking system for
financing the firms. The explanation for this broad institutional difference seems to
be the strength of the underlying legal system (Rajan and Zingales, 2001). Since
the banks are less dependent than the financial markets on the legal system, it is
argued that banks do better when the legal system is weak. The weakness of
underlying legal framework and widespread informality deprive the developing
country financial system from enjoying the virtue of an efficiently functioning
financial market in bringing out the information about the performance of a firm.
Moreover, it suffers from the inherent weakness of the bank-based financial
systems in the form of incompleteness of the debt contracts. The
possibility of renegotiation on default shows off as low expected punishment. The
thin demand for formal credit exacerbates the problem by establishing relation
between the bank and the creditors. The willful default occurs as a consequence.
The close bank-firm relationship where borrowers mainly rely on a single bank for
finance is identified as the most important source behind the loan default and the
consequent banking troubles in Asia.
WILLFUL DEFAULT: THE INDIAN CASE
Public sector banks (PSBs) in India provide the bulk of credit to the Indian economy and
lending decisions in all PSBs are bound by a common set of guidelines issued by the
RBI. Several reasons have been identified in the literature behind the growing incidence
of default (Sarker, 1999; Tarapore, 1999; Rajaraman et al., 1999; Rajaraman and
Vasishtha, 2002; Muniappan, 2002; Mukherjee, 2003; Bardhan and Marjit, 2005). One
natural question arises why the Indian banks are exposed to too much risk of default. One
possible explanation to this phenomenon is that the guidelines under which commercial
banks operate are too much lax leaving room for the banks to risk of default. Lending
decisions are so guided that banks put too much emphasis on the amount of past loans
because it is thought to be a good indicator of what was known
about the borrower at the beginning of the previous period when the loan was granted.
However, in practice, past loans sanctioned do not predict future profits, or the possibility
of default, while current profits do (Banerjee and Duflo, 2002). Banks, in fact, set certain
limits on how much credit (which is guided by certain rules) they are willing to disburse
to their borrowers. Firms differ widely in their needs of credit depending onthe size, type
of business in which they operate etc. It often becomes difficult to rely on the borrowers’
stated needs of credit and thus set a credit limit accordingly because borrowers who have
greater need of credit are often found to be more susceptible to default (Banerjee and
Duflo, 2002). In India, it is observed that big defaulters in banks are eventually the large
firms in the industry. However, banks need to grant loans to those with genuine credit
needs while avoiding those who are likely to default. At this point, it is important to point
out one potential source of loan default. Banks in India
mainly provide loans against collateral security. In case of short-term loan, firm's
inventories serve as security and to that extent working capital loans are less likely to
default. However, even in such cases, there is a significant amount of default arising from
the fact that firms can easily dispose off the inventories that are supposed to be securing
the loan before default and thus hide the proceeds. However, default-friendly legal
system can take little actions against these defaulters, which results in lot of defaults in
most of the PSBs in India.
In India, there was a debate about what should be the appropriate norm for defining
willful default. The default in the banking system occurs due to various reasons like
certain internal factors (e.g., weak credit appraisal or weak loan monitoring process etc.)
as well as certain external factors (e.g., natural disaster, diversion of funds etc.). The RBI
provided the first formal definition of willful default in its guideline issued in 1999. In its
definition, the RBI emphasised on the following points. (a) Deliberate non-payment of
the dues despite adequate cash flows and good net worth. (b) Siphoning off funds to the
detriment of the defaulting units, (c) purchasing as well as selling of assets financed by
the banks and the misutilisation of proceeds, (d) misrepresentation and falsification of
reports, (e) disposal and removal of records without bank’s
knowledge and (f) fraudulent transactions by the borrowers. This guideline became
operational from the beginning of 1999. Accordingly, banks and financial institutions
(FIs) reported all cases of willful defaults, which occurred or were detected after 31 st
March, 1999 on a quarterly basis. It covered all non-performing borrowal accounts with
an outstanding amount of Rs.25 lakhs and above identified as ‘willful default’.
Later on, certain modifications were introduced in the definition of willful default
following the recommendation of the Working Committee (2001) on Willful Default.
Following the recommendations, the modified definition,was put in place by the RBI
(2002) which became operational since May 2002. According to the new guidelines, a
willful default would have occurred in case of the following events: (a) the unit has
defaulted in meeting its payment/repayment obligations to the lender even when it has the
capacity to repay the same obligations, (b) the unit has defaulted its payment/ repayment
obligations to the lender and has not utilised the borrowed funds for specific purposes for
which the loan was granted, rather the funds have been diverted for other purposes, (c)
the unit has defaulted in meeting its payment/repayment obligations to the lender and has
siphoned-off the funds and also the funds are not available in the form of other assets to
the borrower. There are a number of important aspects of the above definitions of willful
default. First, all the borrowing units identified as willful defaulters or the promoters
involved in diversion/siphoning off funds as per the above definition are subject to penal
measures. Second, while dealing with the willful default of a single borrowing unit in a
group, the banks and FIs considered the track record of the individual company with
reference to its repayment performance to its creditors.
However, in cases where a letter of guarantees furnished by the companies within the
group on behalf of the willfully defaulting firm are not honored when appealed by the
banks/FIs, these group companies are also reckoned as the willful defaulters. Third, while
identifying willful defaulters, banks and financial institutions put emphasis on the role of
the auditors of the borrowing units. If it is found there is a falsification of reports on the
part of the borrowers, banks and financial institutions lodge formal complaints against the
auditors of the borrowing units. While monitoring the end-use of the funds, the lenders
can also desire a specific certification from the auditor of the borrowing units regarding
the diversion/siphoning off funds by the borrower. However, the RBI’s decision to create
the list of willful defaulters were subject to mounting criticism in that banks were made
sick by corporate who deliberately refused to pay their dues. In some quarters, it is felt
that at least a portion of default was due to weakening of the indigenous industrial sector
and the national economy as a result of economic reforms and the efforts to globalization.
To that extent default might not qualify as willful. There are some other views which
advocate that firms, which have a strong asset base and market position, could be facing a
cash flow problem as a result of market cycles and other phenomena and these cases
should not be qualified as willful.
CASE STUDY: VIJAY MALLYA
Introduction:
Vijay Mallya, the "King of Good Times", a beer baron has always been on news. All
thanks to his over-the-top, extravagant lifestyle, Mallya and his companies have been
embroiled in financial scandals, and controversies since 2012.
Business Insight:
Mallya became the Chairman of United Breweries Group in 1983 at the age of 28. Since
then, the group has grown into a multi-national conglomerate of over 60 companies.
Mallay’s franchises, mergers, expansions all proved effective until 2005, when he
established Kingfisher Airlines, that landed him in trouble.
The Legal Action:
In November 2015, it came to the limelight that Mallya owed at least $1.35 billion to the
banks in India.
In March 2016, a consortium of banks approached the Supreme Court of India to stop
Mallya from going abroad due to the pending money his companies owed them. Courts
then issued non-bailable arrest warrants against the businessman.
Proposal of Vijay Mallya
Kingfisher Airlines Chairman Vijay Mallya has offered to pay banks Rs. 4,000 crore as
partial settlement of the carrier’s debts and indicated to the Supreme Court that the
atmosphere in India was too vitiated for him to immediately return.
Questions for Consideration:
i) Did the government act in haste by revoking Mallya’s passport even before
gathering foolproof evidence in this case?
ii) Does the ED have strong evidences against Mallya that would stand in the
court of law?
iii) On what basis did the RBI even clear the restructuring of Kingfisher?
iv) How will the banks recover their money?
Conclusion
Mallya’s case is unique in the Indian banking industry in many ways. It is both shocking
and demeaning that an individual has successfully managed to take some 17 banks for a
ride.
Banks acting as charity houses for lending loans to Mallya calls people to question the
credibility of authorities involved in credit appraisal process.
There is finally light at the end of the tunnel as the banking system has finally decided to
lay their hands on the ‘rich and powerful’.
CASE STUDY: NIRAV MODI
Punjab National Bank (PNB), the country’s second-largest public sector lender, is now
in the middle of a ₹11,400 crore transaction fraud case. On Wednesday morning, PNB
informed the Bombay Stock Exchange that it has detected some “fraudulent and
unauthorised transactions” in one of its branches in Mumbai to the tune of $1771.69
million (approx). Following the announcement, the share price of the State-owned bank
plunged 10%. Meanwhile, the Central Bureau of Investigation (CBI) received two
complaints from PNB against billionaire diamantaire Nirav Modi and a jewellery
company alleging fraudulent transactions worth about ₹11,400 crore, the Press Trust of
India reported this is in addition to the ₹280 crore fraud case that he is already under
investigation for, again filed by PNB. Nirav Modi, the billionaire in the middle of this
controversy, is a luxury diamond jewellery designer who was ranked #85 in the Forbes
list of India’s billionaires in 2017 the founder and creative director of the Nirav Modi
chain of diamond jewellery retail stores, and is the Chairman of Firestar International, the
parent of the Nirav Modi chain, which has stores in key markets across the globe.
His designs have been worn to the Oscars by ‘Hidden Figures’ star Taraji P. Henson and
to the Golden Globes by Dakota Johnson, among others. Actor Priyanka Chopra is the
brand ambassador.
Modus Operandi?
In a statement issued to stock exchanges on Wednesday, PNB said that it has detected
some “fraudulent and unauthorised transactions (messages)”
A stock statement is a business statement that provides information on the value and
quantity of stock related transactions. It details opening and closing balances for
transacted items as well.
According to the complaint filed by PNB with the CBI on January 28, the fraudulent
issuance of Letters of Undertakings (LOU) was detected at the Mid Corporate Branch,
Brady House in Mumbai.
What are major the differences between an SME, mid-corporate and lar?
crore Mid Corporate branches give credit upto ₹50 crore Large Corporate branches have
large credit exposure of major corporate clients with credit limit of ₹50crore and more.
headed by AGM, while Large Corporate branches are headed by DGM and above,
depending on Bank business.
Letter of Understanding?
A contract to perform the promise, or discharge the liability, of a third person in case of
his default Bank Provisioning overseas lenders such as banks and other financial
institution for goods they are importing Diamond R US, Solar Exports and Stellar
Diamonds approached the bank on January 16 with a set of import documents and
requested for Buyer’s Credit to make payments to overseas suppliers.
Nirav Modi, and Mehul Chinubhai Chokshi as partners. Buyers Credit is, typically, a
short-term loan facility extended to an importer by a bank to finance goods and services.
It is a common mode of transaction in international trade where a bank extends credit to
the importer and a finance agency based in the exporter’s country guarantees the loan.
As there was no sanctioned limit in the name of the firms, the branch officials requested
the firms to furnish 110% cash margin for issuing the LOU for raising the Buyer’s Credit.
At this, the firms contested that they have been availing this facility in the past; but the
branch records do not corroborate this. On digging further, the bank officials discovered
that two of its employees had fraudulently issued LOUs in the past without following
prescribed procedures and approvals. branches of Indian banks for raising Buyer’s Credit
without making entries in banking system to avoid detection.
SWIFT Code:
Society for Worldwide Interbank Financial Telecommunication code. An internationally
recognized identification code for banks around the world, and are comprised of 8 or 11
alphanumeric characters, authoritative body that approved the creation of SWIFT codes
The complaint also said that the funds so raised for the payment of the Import Bills have
not been utilised for such purposes in many cases.
As per the FIR, five of the SWIFT messages (SWIFT is a messaging network used by
financial institutions to securely transmit instruction) were issued to Allahabad Bank in
Hong Kong and three to Axis Bank in Hong Kong.
What will happen now?
One of the worrying aspects of the scam is that in its statement, PNB says that based on
the fraudulent transactions, other banks appear to have advanced money to the customers
abroad. Contingent in nature and any liability arising out of these on the bank will have to
be decided based on the law and genuineness of underlying transactions.
What is a ‘Contingent Liability?’
A contingent liability is a potential liability that may occur, depending on the outcome of
an uncertain future event. Contingency is probable and the amount of the liability can be
reasonably estimated.
Liability may be disclosed in a footnote to the financial statements or not reported at all.
Rajan said “I don’t think this is out of control or too big a worry at this point. That is my
broad sense.”
Department of Financial Services?
The Department of Financial Services covers Banks, Insurance and Financial Services
provided by various government agencies and private corporations.
e and Micro, Small and Medium Enterprise. It started the Pradhan Mantri Jan Dhan
Yojana is a statutory body which also works under this department. Rajiv Kumar is the
current Secretary of this department. Government is attempting to provide a breather to
ailing PSBs, having announced a ₹2.11 lakh crore received Rs 5,473 crore as capital
infusion from the government through a mix of recapitalisation bonds and direct infusion.
7 As of now, as Reuters (An international news agency founded in London in 1851 by
Paul Julius Reuter (1816–99)) opined, the only good that could come out of the affair
would be some fresh consideration to implementing better practices in public sector
banking.
HIGHLIGHTS
Punjab National Bank (PNB) disclosed that it has detected some fraudulent transactions
with financial implication of $1.77 billion.
The matter has been referred to law enforcement agencies for the recovery.
NEW DELHI: Major jewellers Gitanjali, Ginni and Nakshatra have also come under the
scanner of various investigating agencies following PNB's declaration of Rs 11,400 crore
fraud, committed allegedly by Nirav Modi.
Punjab National Bank (PNB) disclosed this morning that it has detected some fraudulent
transactions with financial implication of $1.77 billion (about Rs 11,346 crore) and the
matter has been referred to law enforcement agencies for the recovery.
Four big jewellers -- Gitanjali, Ginni, Nakshatra and Nirav Modi -- are under scanner.
The CBI and Enforcement Directorate is looking at their arrangements with various
banks and end use of money," a senior official of a public sector bank told PTI.
No immediate comments were available from these companies.
There is strict instruction from the finance ministry to all banks that no big fish should go
scot free and no honest borrower is harassed, the official said. Banks are now looking at
their systems and processes so that such frauds are not repeated, the official said.
All banks have been asked to present a status report as soon as possible, he added.
In 2015, Bank of Baroda -- another public sector bank -- had brought to light a scam in
which two Delhi businessmen cheated it of Rs 6,000 crore which slightly less than $1
billion at that time. Investigations revealed major irregularities, because the forex
transactions were done mainly via advance remittances for import, through newly-opened
current accounts. Heavy cash transactions -- sometimes four or five times a day -- were
also noticed.
The Enforcement Directorate, under the revenue department of the finance ministry, had
arrested the businessman duo under money laundering provisions. PNB said in a
statement that fraudulent transactions took place in one of its branches in Mumbai for the
benefit of a few select account holders with their apparent connivance. Based on these
transactions, done by his brother Nishal, wife Ami and Mehul Chinubhai Choksi, other
banks appear to have advanced money to these customers abroad. The CBI had received
two complaints from the PNB against billionaire diamantaire Nirav Modi and a jewellery
store.
Major jewellers Gitanjali, Ginni and Nakshatra have also come under the scanner of
various investigating agencies following PNB's declaration of Rs 11,400 crore fraud,
committed allegedly by Nirav Modi. Punjab National Bank (PNB) disclosed this morning
that it has detected some fraudulent transactions with financial implication of $1.77
billion (about Rs 11,346 crore) and the matter has been referred to law enforcement
agencies for the recovery. "Four big jewellers Gitanjali, Ginni, Nakshatra and Nirav Modi
are under scanner. The CBI and Enforcement Directorate is looking at their arrangements
with various banks and end use of money," a senior official of a public sector bank told
PTI. No immediate comments were available from these companies. There is strict
instruction from the finance ministry to all banks that no big fish should go scot free and
no honest borrower is harassed, the official said.
Banks are now looking at their systems and processes so that such frauds are not
repeated, the official said. All banks have been asked to present a status report as soon as
possible, he added.
In 2015, Bank of Baroda another public sector bank had brought to light a scam in which
two Delhi businessmen cheated it of Rs 6,000 crore which slightly less than $1 billion at
that time.
Investigations revealed major irregularities, because the forex transactions were done
mainly via advance remittances for import, through newly-opened current accounts.
Heavy cash transactions -- sometimes four or five times a day -- were also noticed.
The Enforcement Directorate, under the revenue department of the finance ministry, had
arrested the businessman duo under money laundering provisions. PNB said in a
statement that fraudulent transactions took place in one of its branches in Mumbai for the
benefit of a few select account holders with their apparent connivance. Based on these
transactions, done by his brother Nishal, wife Ami and Mehul Chinubhai Choksi, other
banks appear to have advanced money to these customers abroad. All this was being
carried out in connivance with officials as high as Deputy General Manager since 2011.
The CBI has received two complaints from the PNB against billionaire diamantaire Nirav
Modi and a jewellery company alleging fraudulent transactions. Nirav Modi, whose
jewellery creations are popular among global celebrities, may face a fresh CBI probe as
the agency is looking at suitable legal action to be taken in the case.
He is already being investigated by the CBI for alleged cheating and fraud involving Rs
280 crore at a PNB branch. The news of Rs 11,363 crore fraudulent transactions at
Punjab National Bank has raised questions on the efficacy of the public sector banks vis-
a-vis its lending procedures.
The fraud carried out by Nirav Modi, a well-known jewellery designer and a billionaire
diamond trader, will further dent the credibility of the already-stressed banking system in
the global arena. The latest fraud is being touted as even higher than the Vijay Mallya's
default of around Rs 9,000 crore. A day after revelation, the Enforcement Directorate, on
Thursday, launched a countrywide raid on the offices, showrooms and workshops of
Nirav Modi. The bank has suspended its 10 bank employees but it is not clear, as media
reports say, if action against members from the PNB Credit Approval Committee or its
Board of Directors have been taken. On January 29, PNB informed India’s Central
Bureau of Investigation (CBI) that two employees posted at the Mumbai branch had
illegally issued “letters of undertaking” to get the overseas branches of Indian banks
extend credit to “a few select account holders,” related with Nirav Modi. The following
day, it filed a complaint against the alleged fraud. PNB says its employees bypassed the
lender's internal messaging system and issued instructions through the Swift global
payment system in order to avoid detection.
The CBI, last week, booked Firestar Diamonds group along with Modi, his wife Ami
Nirav Modi, brother Nishal and a maternal uncle Mehul Choksi, who owns Geetanjali
Group. The fraud was unearthed last month, when Modi's companies applied for a fresh
loan from the bank. As the employee in question had retired, other staff placed at his
position refused to approve the loan. This was the point when the bank unearthed the
fraud and the fake letters of undertaking. PNB Chief Executive Officer Sunil Mehta said,
on Thursday, the bank is in talks with other banks to decide on the liabilities, however, it
will follow the regulator's instructions on repayment. PNB, as NDTV reports quoting
Bloomberg, has named Hong Kong branches of Axis Bank Ltd and Allahabad Bank as
the overseas counterparties.
Mechanism for identification of Wilful Defaulters
(a) The evidence of wilful default on the part of the borrowing company and its
promoter /whole-time director at the relevant time should be examined by a Committee
headed by an Executive Director or equivalent and consisting of two other senior officers
of the rank of GM / DGM.
(b) If the Committee concludes that an event of wilful default has occurred, it shall issue
a Show Cause Notice to the concerned borrower and the promoter / whole-time director
and call for their submissions and after considering their submissions issue an order
recording the fact of wilful default and the reasons for the same. An opportunity should
be given to the borrower and the promoter / whole-time director for a personal hearing if
the Committee feels such an opportunity is necessary.
(c) The Order of the Committee should be reviewed by another Committee headed by the
Chairman / Chairman & Managing Director or the Managing Director & Chief Executive
Officer / CEOs and consisting, in addition, to two independent directors / non-executive
directors of the bank and the Order shall become final only after it is confirmed by the
said Review Committee. However, if the Identification Committee does not pass an
Order declaring a borrower as a wilful defaulter, then the Review Committee need not be
set up to review such decisions.
(d) As regard a non-promoter / non-whole-time director, it should be kept in mind that
Section 2(60) of the Companies Act, 2013 defines an officer who is in default to mean
only the following categories of directors:
(i) whole-time director
(ii) where there is no key managerial personnel, such director or directors as specified by
the Board in this behalf and who has or have given his or their consent in writing to the
Board to such specification, or all the directors, if no director is so specified;
(iii) every director, in respect of a contravention of any of the provisions of Companies
Act, who is aware of such contravention by virtue of the receipt by him of any
proceedings of the Board or participation in such proceedings and who has not objected
to the same, or where such contravention had taken place with his consent or connivance.
Therefore, except in very rare cases, a non-whole-time director should not be considered
as a wilful defaulter unless it is conclusively established that:
I. he was aware of the fact of wilful default by the borrower by virtue of any proceedings
recorded in the minutes of meeting of the Board or a Committee of the Board and has not
recorded his objection to the same in the Minutes; or,
II. the wilful default had taken place with his consent or connivance.
The above exception will however not apply to a promoter director even if not a whole-
time director.
(iv) As a one-time measure, Banks / FIs, while reporting details of wilful defaulters to the
Credit Information Companies may thus remove the names of non-whole-time directors
(nominee directors / independent directors) in respect of whom they already do not have
information about their complicity in the default / wilful default of the borrowing
company. However, the names of promoter directors, even if not whole-time directors, on
the board of the wilful defaulting companies cannot be removed from the existing list of
wilful defaulters.
(e) A similar process as detailed in sub-paragraphs (a) to (c) above should be followed
when identifying a non-promoter / non-whole-time director as a wilful defaulter.
