Latest Articles:

1. RBI Stops Buyers Credit Transactions (LOU & LOC)
2. Indian Banks adds Additional Control to SWIFT System
3. Bank Audit – Buyers Credit and Nostro Account

This article gives layman summary of the PNB fraud case and its impact on buyers credit product and various stake holders like Indian Bank Overseas Branches, Local Banks in India and Importers.

Summary of Case

Letter of Credit (LC) and Buyers Credit transactions were done without funded base or non fund based  limits and underlying security (Fixed Deposit or Assets ) in place. This was done by issuing LC and Letter of Undertaking (LOU) to overseas branches using SWIFT message without making entries in Core Banking System (CBS).  As per regulator requirement, even in case of 100% cash backed (FD) margin, bank has to create limits stating security as FD and then only any transaction is allowed.

Missed Internal Control 

1. Swift systems not connected to Core Banking System (CBS). Branch staff was able to send LOU swift without routing transaction through CBS. RBI in its 2016 Circular to banks had mentioned problem in relation to process followed for issue and reconciliation of SWIFT messages related to Trade finance products and corrective actions banks should take to prevent any fraud.
2. When LOU / LC is sent, bank charges LOU charges from importers account. Either this charges where not debited to importers account, which means loss in revenue for bank side or charges were debit from importers bank account then there was  trail of transactions which was missed during audit.
3. Nostro reconciliation. All credit and debit entries goes to Nostro Mirror Account maintained in CBS. All funding for buyers credit would have reflected in Nostro and reconciled. Only in case where overseas branches funded directly to supplier (as per instruction in LOU), credit entry will not be reflected but still debit entry for repayment of principal and interest will always be there.
4. Audit of swift messages.

Impact on Overseas Indian Bank Branches

1. Overseas Indian Bank branches are verifying each and every buyers credit outstanding in their books with LOU issuing bank and asking for confirmations.
2. Few banks have cancelled offer letter already issued against which funding is pending.
3. Overseas branches are avoiding buyers credit transaction of Punjab National Bank.
4. Few overseas branches, have temporary stopped doing buyers credit.
5. Few overseas branches  have amended or in process of amending the LOU formats to include more details of underlying import transaction and adding additional clause to protect their interest.
6. Increased documentation. Some banks are asking for copy of Invoice and BL copy with every transaction before funding. Some are asking invoice and BL even before issuing quote.
7. Insisting on funding the transaction in Nostro account of LOU issuing bank only. Earlier there were banks which  had an option of funding nostro of Supplier’s Bank directly and providing a confirmation swift to LOU issuing bank.

Impact on Local Bank

1. Updating or link system between SWIFT and CBS
2. Centralizing SWIFT systems instead of branch based systems.
3. Temporary local bank have or may stop issuing LOU.
4. Few banks are insisting that whole leg of transaction is routed through them. Example: For importer enjoying limits with SBI branch, will have to approach only local SBI branch for quote. In turn, local SBI Branches will only take quote  from SBI Overseas branches.
5. Before this incident, LOU issued for buyers credit transaction were consider under lesser risk  and thus required lesser provisioning under Basel III norms issued by RBI. There may be a change in this provision. RBI is yet to clarify on the same.

Impact on Importer

1. As number to branches quoting have come down, fresh quote for overseas branches are hard to come by.
2. Buyers Credit pricing have gone up and thus increasing overall costing of transaction.
3. Operating time of getting a transaction through has gone up. Earlier which used to take 2 – 3 days to complete the whole transaction not taken 10 – 15 days.
4. Few bank have cancelled all the existing offer letter for which funding is pending. For those importers where banks have cancelled existing offer letter, will have to get fresh offer letter from new bank; which is currently difficult to come by.
5. Few banks are insisting that whole leg of transaction is routed through them. Example: For importer enjoying limits with SBI branch, will have to approach only SBI branch for quote. And SBI Branches will only take quote  from SBI Overseas branches.
   • Increase time of transaction processing time.
   • Branch staff is not equipped with process.
   • Branch staff overload and least priority thing for them.
   • Costing will go up as importer will not have option to negotiate on price.
6. Importer whose import is under process and incase is not able to arrange buyers credit, will have to go to Cash Credit or Term loan depending on goods. Thus will increase overall cost.

RBI Statement on the case:

The fraud in PNB is a case of operational risk arising on account of delinquent behaviour by one or more employees of the bank and failure of internal controls. 

Regulatory Updates

1. The Reserve Bank has set an April 30 deadline for all banks to link the Society for Worldwide Interbank Financial Telecommunications (SWIFT) with their core banking solution (CBS)
2. RBI initiates special audit of PSBs with focus on trade finance
3. Government: Public Sector Banks (PSBs) to consolidate 35 overseas operations without affecting international presence of PSBs in these countries; 69 ops identified for further examination. Move towards cost efficiencies and synergies in overseas market.
4. ICAI Launches Investigation Into PNB Fraud
5. Cabinet To Notify Audit Regulator NFRA, Approves Draft Rules 

Conclusion

• The instrument is blamed taking the focus away from the system failure in PNB
• Buyers Credit as a product worked with importer because of the simplicity and turn around time. Post PNB case, process and turn around time has increased so much that structure itself will be left of no use.
• If one look at the RBI statement, RBI has not questioned the product (buyer’s credit) but the process and controls of the bank. It seems Buyers Credit product will survive but requirement of document or process may change both at local bank level and overseas bank branch level.
• Also there seems to be panic among banks because of which many overseas branches have temporarily  stopped quoting for buyers credit transaction. This is impacting genuine requirement for importer of raw material and capital goods. If continuous for long, SME importer will be most impacted as their cost of borrowing will go up.
• As per information available till now (through news), only lack in process from overseas bank it seems is related to funding / rollover of buyers credit over and above 90 days for goods related to PNB Case. As per one article even that point is contested by overseas branches stating underlying goods were pearls which is not part of 90 days restrictions. One can confirm the same only post checking relevant documents.
  • For most goods imports, buyers credit allowed upto operating cycle or 360 days from date of shipment which ever is lower.
  • 90 Days tenure is applicable for Import of Gold Jeweler Including Jewellery Made of Precious Metals or/and Studded With Diamonds / Precious Stones /Semi-precious.  Import of Platinum /Palladium/Rhodium/ Silver/Rough, Cut & Polished Diamonds / Precious and Semi-precious Stones.

Note:

1. Will keep updating this article as and when further information is available.
2. Information related to PNB case used are based on information available in public domain.

Reference

1. RBI Statement
2. RBI Appoints Expert Committee headed by Mr. Y M Malegam
3. Cyber Security Controls — frauds related to trade finance transactions — misuse of SWIFT
4. Information Technology & Cyber Risk in Banking Sector – The Emerging Fault lines – S. S. Mundra
5. Concurrent Audit System in Commercial Banks – Revision of RBI’s Guidelines
6. Guidance Note on Audit of Banks (2017 Edition)
7. Guidance Note onAudit of Banks- 2018 Edition
8. The Anatomy of the PNB fraud.
9. PNB Fraud: Hong Kong regulator seeks status report from Indian banks 
10. PNB fraud case: Axis Bank says ‘sold down’ LoU transactions
11. PNB scam: Is RBI going back on its rules on letters of credits? 
12. PNB fraud case: Officials of other banks under scanner
13. How did everyone miss the PNB scam? An accountant explains what could have gone wrong 
14. Nirav Modi case: Bank officials may have made close to Rs 823 crore in PNB fraud
15. To counter PNB stand, banks likely to cite 180-day rule
16. India Ratings Places Firestar International on RWN
17. https://www.indiaratings.co.in/Search?searchKey=firestar
18. Banks relied on India Ratings’ A- outlook to lend to this Nirav Modi firm
19. The gaping holes in Nostro account monitoring and the SWIFT messaging system: thewire.in
20. PNB scandal: Glossed over, auditors flagged loan default, forex violations
21. Nimo fallout on imports
22. Corporate banks in a world of pain 
23. Why auditors in India must keep up with technology

24. Loose ends and unanswered questions of the PNB scam