The biggest financial fraud in India's history just got bigger.
On Monday, Punjab National Bank disclosed that a fraud previously believed to be $1.7 billion had swollen to $2 billion as the true extent of the fraud is still coming into focus.
But the impact that this now-$2 billion fraud has had on the shares of PNB and other state-run Indian banks is having a wide-ranging impact across the country's financial system, according to Bloomberg.
Foreign banks, worried about the systemic lapses that the scandal has exposed, have become unwilling to lend money to smaller Indian firms - causing massive disruptions in trade finance. All of this pressure has hammered the Indian rupee, which is on track for its first monthly drop since September. This is largely because India's economy, like the US, runs a trade deficit, and depends on capital inflows to function.
Foreign capital comes through foreign funds’ purchases of Indian stocks and bonds, local exporters’ sale of foreign-currency earnings and dollar loans from foreign banks. India is one of the world’s biggest users of trade funding worldwide, according to the ICC Global Survey 2017.
The fraud was purportedly masterminded by Nirav Modi and his uncle Mehul Choksi, both of whom are on the run.
The two men worked with a PNB employee named Gokulnath Shetty, who recently retired. Shetty would issue fraudulent letters of undertaking to help companies create by Choksi and Modi apply for loans through the foreign branches of other Indian banks. The fraud continued as, when it came time to repay the loans, Shetty would issue still more LoU's to cover the balance.
Citigroup Inc., Deutsche Bank AG, Standard Chartered Plc and HSBC Holdings Plc are among banks reducing exposure to these transactions, used by smaller companies to access short-term dollar funding, said people with knowledge of the matter. As questions are raised about the creditworthiness of guarantees from Indian state-run banks, rates have risen by as much as 0.5 percentage point for some types of financing, the people said, asking not to be identified as the details are private.
Spokesmen in Mumbai for Deutsche Bank, HSBC and Citigroup declined to comment. “We continue to support our clients on transactions that meet our internal controls and standards,” a spokesman for Standard Chartered said by email.
If doubts about the safety of Indian firms continue to grow, some firms may soon be forced to pay a full percentage point above Libor, compared with 0.5 percentage point before the PNB fraud was disclosed. As Bloomberg points out, the interlinked nature of global trade means trust is a crucial component of these transactions.
The one silver lining is that at least larger Indian companies, which have direct access to funding from foreign lenders and don’t rely on interim guarantees, haven't been affected by the credit crunch.
Possibly making matters worse, PNB has blamed other banks for negligence by failing to detect the fraud, though the fact that the bank's internal controls weren't connected to SWIFT - the international banking telecommunications system - making it much more difficult to detect the fraud.
So the real question is: Will India's banking regulators finally act to install meaningful controls? Or will the fallout from this short-term finance crunch continue to worsen until it blossoms into an acute capital-flight crisis.