PNB fraud: Need for Banking Sector Reforms in India


In a regulatory filing last week, Punjab National Bank reported a Rs 11,394 crore fraud involving billionaire jeweller Nirav Modi. The government has ordered a probe by agencies such as the CBI, Enforcement Directorate and the Income-Tax Department in this regard.

What has happened?

  • Recently, PNB found that the SWIFT system had been misused by junior-level branch officials, who had fraudulently issued letters of undertaking (LoUs) on behalf of some companies for availing buyer’s credit from overseas branches of Indian banks.
  • The alleged fraud was carried out through misuse of Letters of Undertaking or LoUs issued by Punjab National Bank
  • Preliminary investigation into the alleged fraudulent transactions worth ₹11,500 crore has revealed a complete breakdown of supervision and auditing mechanism in Punjab National Bank’s Mumbai branch and overseas branches of the other banks concerned.
  • The transactions remained undetected for almost seven years, despite the fact that the bank conducts internal and external audits on a regular basis.
  • Overseas branches of the other banks, which released payments on the request for settlement of import bills, also did not flag the discrepancies for such a long period.
  • The bank has pinned the whole blame on the then Deputy Manager, Gokulnath Shetty, and a low-rank staffer for the fraudulent issuance of Letters of Undertaking (LoU) on behalf of the three firms associated with diamond merchant Nirav Modi and his family members.
  • These incidences raise the concern for banking sector reform in India.

What are the major challenges banking sector is facing today?

Bad loan:

  • A bad loan is a loan where repayments are not being made as originally agreedbetween the borrower and the lender, and which may never be repaid.
  • These bad loans are squeezing banks’ profitability and capital positions, threatening the health of some of India’s biggest banks.

Cyber threats:

  • With the growing penetration of computers and smartphones, and increasing access to the internet, Indians are taking to digital channels for their banking needsfor which cybercrime is becoming a greater threat.
  • The RBI classifies bank fraud as transactions involving any cheating, negligence, misappropriation of funds, or forged documents.

Bank fraud:

  • Another pressing concern for the banking regulator is the increased number of fraudulent transactions at Indian banks. Recent example is Punjab National Bank reported a Rs 11,394 crore fraud involving billionaire jeweller Nirav Modi.
  • What’s adding to the concerns is that banks often seem reluctant to report these cases.

The new Bankruptcy Code:

  • The biggest change came from the new bankruptcy code that provide for a faster resolution of stressed assets in a time bound manner. Bankers are hopeful of clearing the stock of bad debts with some gains in the books

Use of bots  and artificial intelligence :

  • The adoption of AI  and bots is gradually taking place in the banking industry.   Some banks have launched software robotics to for repetitive call centre jobs.  The adoption of AI is going to transform many of the segments of banks especially ‘sales platform’ and ‘customer service.
  • Huge non-performing assets.
  • Recapitalize public sector banks to strengthen their ability to expand credit.
  • Low Credit Offtake :The credit offtake is still low at around 70 per cent. The public sector banks (PSBs ) are anyway staying away from lending , while private sector banks are selectively  offering refinancing to good corporate.

Committees on banking reforms:

Recognizing the evolving needs of the sector, the Finance Ministry of   set up the various committees with the task of analysing India’s banking sector and recommending legislation and regulations to make it more effective, competitive and efficient

Narasimham Committee-I (1991) report:

  • They submitted their recommendations in the 1990s in reports widely known as the Narasimham Committee-I (1991) report and the Narasimham Committee-II (1998)
  • These recommendations not only helped unleash the potential of banking in India, they are also recognised as a factor towards minimising the impact of  global financial crisis starting in 2007.

Major recommendations of Narasimham Committee:

  • Non-performing assets: Non-performing assets had been the single largest cause of irritation of the banking sector of India. The committee had highlighted that ‘priority sector lending’ was leading to the buildup of non-performing assets of the banks and thus it recommended it to be phased out. The committee’s recommendations let to introduction of a new legislation which was subsequently implemented as the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and came into force with effect from 21 June 2002.
  • Capital adequacy and tightening of provisioning norms: To improve the inherent strength of the Indian banking system the committee recommended that the Government should raise the prescribed capital adequacy norms.This would also improve their risk taking ability. he mid-term Review of the Monetary and Credit Policy of RBI announced another series of reforms, in line with the recommendations with the Committee, in October 1999
  • Entry of foreign banks: The committee suggested that the foreign banks seeking to set up business in India should have a minimum start-up capital of $25 million as against the existing requirement of $10 million.
  • Stronger banking system: The Committee recommended for merger of large Indian banks to make them strong enough for supporting international trade. However, the recommended degree of consolidation is still awaiting sufficient government impetus.

Implementation of recommendations:

  • In 1998, RBI Governor Bimal Jalan informed the banks that the RBI had a three to four-year perspective on the implementation of the Committee’s recommendations. Based on the other recommendations of the committee, the concept of a universal bank was discussed by the RBI and finally ICICI bank became the first universal bank of India.
  • Most of the recommendations of the Committee have been acted upon (as discussed above) although some major recommendations are still awaiting action from the Government of India.

 What types of reforms are required for banking sector?

The major reforms relating to the banking system are given below:

  • Reducing the government equity below 51%, and attracting some strategic investors, would be a very major step.
  • It will not only reduce the pressure on the budget to provide funds for recapitalization, it will also set the stage for a more commercial orientation for public sector banks.
  • Capital adequacy and tightening of provisioning norms

Recent steps taken by the government:

  • As part of its resolve to bring down burgeoning NPAs, the government issued two ordinances — Banking Regulation (Amendment) Ordinance, 2017 and Insolvency and  Bankruptcy Code Code (Amendment) Ordinance, 2017 – during the year.
  • The Banking Regulation (Amendment) Ordinance, 2017 gave way to the Act permitting the Reserve Bank of India (RBI) to direct any bank to initiate insolvency proceedings and give directions for resolution of stressed assets.
  • In a blow to defaulting promoters seeking to reclaim their firms that are under insolvency proceedings, the government last month promulgated an ordinance to bar wilful bank loan defaulters as well as those with NPA accounts from bidding in auctions being done to recover loans.
  • In August 2015, finance minister Arun Jaitley announced the grand Indradhanush plan—the “solution to the problems” of the industry, which Modi explored in Gyan Sangam. It promises to tackle several critical issues,including appointments, capitalization, stress in the system, empowerment, accountability and governance reforms to revamp functioning of the government-owned banks.

Other steps taken for banking reforms:

  • Accelerate recoveries from non-performing assets:
  • The Strategic Debt Restructuring Scheme allows banks to convert the debt into equity, take control of the project, remove the existing management, and induct new management.
  • The second option is to work with the existing management and negotiate a suitable debt reduction. This is what the RBI’s most recent Scheme for Sustainable Structuring of Stressed Assets (S4A) was designed to do.

Recapitalize public sector banks to strengthen their ability to expand credit:

  • The Reserve Bank of India has placed, a significant part of the recapitalization plan, under the prompt corrective action, or PCA, framework
  • The RBI deploys the PCA to monitor the operation of weaker banks more closely to encourage them to conserve capital and avoid risks
  • For these entities, this capital(provided under the plan) offers a fresh lease of life as it will help meet regulatory requirements under the Basel-III regime
  • Also, it cushions them to an extent from possible haircuts on stressed loans that are going through the insolvency resolution process


Reforms in the banking sector and tightening of processes would prevent a repeat of a fraud that is unparalleled in the Indian banking history. Recapitalisation alone cannot be the panacea. It is extremely crucial that the banking reforms are properly sequenced and executed in time. Certainly, the need of the hour is another high-powered committee.

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