International Journal of Research in Economics and Social Sciences (IJRESS)

Available online at: http://euroasiapub.org

Vol. 8 Issue 3, March - 2018
ISSN(o): 2249-7382 | Impact Factor: 6.939 |

Impact of PNB Scam on Banking Sector and Investors in India: An Empirical Study

Dr. Shriprakash Soni1

Associate Professor and HOD MBA
Suryadatta Institute of Business Management and Technology, Pune

Dr. Harshal Salunkhe2

Assistant Professor, MBA Department
Suryadatta Institute of Business Management and Technology, Pune

Abstract:
On 14th February, 2018 Banking Industry of India registered a big scam in the form of Letter of
Understanding (LoU) scam of PNB. The PNB is second largest public sector bank in India with good
market capitalization. The size of this scam is near about Rs.11400 crore, Mr. Nirav Modi’s firms
sought the LoU to get buyers’ credit from foreign banks whereby they can finance diamond imports
to India.

In this paper, the researchers have discussed the case study of Punjab National Bank (PNB) and its
impact on banking sector and investors in India.

Keywords:
PNB Scam, Letter of Understanding, Buyer’s Credit.

International Journal of Research in Economics & Social Sciences 321

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(An open access scholarly, peer-reviewed, interdisciplinary, monthly, and fully refereed journal.)
International Journal of Research in Economics and Social Sciences (IJRESS)
Vol. 8 Issue 3, March- 2018
ISSN(o): 2249-7382 | Impact Factor: 6.939

Introduction:
The Punjab National Bank (PNB) is one of the leading nationalized banks in India. The operations
of PNB are not limited to India as it is Multinational bank. PNB operates in UK, Hong Kong,
Australia, Dubai, Bhutan, Kazakhstan, China, Nepal and Bangladesh. PNB had consolidated total
assets INR 7.321 trillion and deposits of INR 6.362 trillion and total net profit of bank was Rs. 902
crores in September, 2017. PNB’s founders included several leaders of the Swadeshi movement.
PNB is the first Indian bank which started solely with the Indian capital and survived till date. On
19thMay, 1894 PNB was registered under the Indian Companies Act. The business of bank was
started on 12th April, 1895.

During the history of 122 years, the 7 different banks have merged with PNB. PNB have total 6941
domestic branches and 9753 ATMs all over India. The total numbers of customers of PNB is 10
crore as on today. The gross and net NPA of PNB was 13.31% and 8.44% as on September, 2017
respectively. It is very less as compared to other nationalized banks in India.

Objective of the Study:

To study the impact of PNB scam on banking sector and investors in India.

Research Methodology:
Data published in different newspapers, several articles and many websites is referred to
background study. Informal discussions with the Experts in Banking Sector, practicing Chartered
Accountants and Investment Consultants, finance faculty members were held with the help of
semi-structured questionnaire.

Scam in PNB:
The Punjab National Bank’s Brady House Branch in Mumbai issued fraudulent Letter of
Undertaking (LoU) worth of Rs. 11,400 crores in favour of Diamond Trader Mr. Nirav Modi’s firms.
His firms sought the LoU to get buyers’ credit from foreign banks whereby they could finance
diamond imports to India. This LoU was taken towards guarantee for overseas lenders (banks) to
get money from them. Here, foreign branches of three Indian banks – Allahabad Bank, Axis Bank
and Union Bank of India, provided credit to Mr. Nirav Modi’s firms based on the PNB LoUs.

Primary report of PNB indicates that the LoU was issued without proper authorization. This
means that some officials in the bank have done a favour to Mr. Nirav Modi. To understand the
entire issue behind the scam, a proper understanding of concepts like Buyers’ credit and LoU is
needed. The whole scam came into limelight when Mr. Nirav Modi failed to make repayment on
time due to financial trouble. Initial enquiry shows that LoUs were issued back date from 2012-
13. The non-payment implied that the default burden fell on the shoulders of PNB (not on the
three Indian banks) as LoU was a financial guarantee in case of non-payment by the Mr. Nirav
Modi. PNB has alleged that two of its employees “fraudulently” issued LoUs and “transmitted
SWIFT instructions to the overseas branches of Indian Banks” to raise buyers’ credit for Mr. Nirav
Modi’s firms.

Buyer’s Credit:
In simple words, Buyer’s Credit is a loan facility extended to an importer by a bank or financial
institution to finance the purchase of capital goods or services. Buyer’s credit is an useful mode of

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(An open access scholarly, peer-reviewed, interdisciplinary, monthly, and fully refereed journal.)
International Journal of Research in Economics and Social Sciences (IJRESS)
Vol. 8 Issue 3, March- 2018
ISSN(o): 2249-7382 | Impact Factor: 6.939

financing in international trade. Usually, for bulk purchases the importers (foreign buyers) hardly
pay cash, while the capability to extend considerable amounts of long-term credit to their buyers
is having by few exporters only. A facility of buyer’s credit involves a bank that can extend credit
to the importer, as well as an export finance agency based in the exporter’s country that
guarantees the loan. The buyer’s credit includes cross-border legalities and multiple parties.
Generally, it is only available for large export orders, with a minimum threshold of a few million
dollars.

Letter of Understanding:
A LOU or Letter of Understanding is a formal document which includes the terms and conditions
of understanding of a contract which mostly has been negotiated up to this point only in spoken
form. It reviews the terms and conditions of an agreement for a service, a project or a deal and is
often written as a step before a more detailed contract is issued. In universal banking system,
Letter of Undertaking (LOU) is a provision of bank guarantee, under which a bank allows its
customers to raise money from another Indian bank’s foreign branch in the form of a short term
credit. It serves the purpose of a bank guarantee. However, the customer is supposed to pay
margin money to the bank issuing the LOU to be able to raise the LOU and accordingly, he is
granted a credit limit.

The LOU in the cases of the PNB case means that the PNB will pay the amount if Mr. Nirav Modi
doesn’t pay the loan obtained from the issuers of buyers of credit (Axis bank etc.).

Impact on Investors:
 The PNB is a second largest public sector bank in India having a market capital of Rs.30477.40
crores.
 The announcement of fraud came into public, PNB share went down by 10% on 14th February,
2018. Rs.4,000 crores investors’ money considering the magnitude of the scam which is nearly
one third the market capitalization of PNB.
 The decreasing prices of the shares will further directly impact the mutual fund schemes that
are holding shares of PNB. Many mutual fund houses had invested in PNB. It is a part of the
equity portfolio of 117 mutual fund schemes. Especially, equity oriented schemes hit much
more to this scam.
 The PNB share went down up to 36 % in last one month (from 14.2.2018 to 23.3.2018). The
share price of PNB hits 52 weeks low as Rs.93.15 on 23.3.2018. The more than Rs.13,000
crores of investors’ wealth has been wiped out.
 The below table shows the details about PNB share trading on BSE in one month (from
14.2.2018 to 23.3.2018) regarding open, high, low, close and volume.

International Journal of Research in Economics & Social Sciences 323

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(An open access scholarly, peer-reviewed, interdisciplinary, monthly, and fully refereed journal.)
International Journal of Research in Economics and Social Sciences (IJRESS)
Vol. 8 Issue 3, March- 2018
ISSN(o): 2249-7382 | Impact Factor: 6.939

Date Open High Low Close Volume

14-02-2018 160.00 160.00 144.70 145.80 5284239

15-02-2018 137.00 139.70 125.55 128.35 17210918
16-02-2018 125.05 128.40 120.60 125.65 11728033
19-02-2018 122.70 123.40 113.60 116.40 9895137
20-02-2018 113.50 118.40 111.00 116.55 11208862
21-02-2018 117.80 119.50 115.60 117.10 4666212
22-02-2018 114.80 116.70 113.70 114.65 2797680
23-02-2018 114.40 116.85 112.35 113.40 3101753
26-02-2018 113.45 114.95 110.25 111.90 3230607
27-02-2018 107.80 107.80 96.10 98.35 14907301
28-02-2018 94.00 102.25 92.00 101.35 16783225
01-03-2018 100.85 103.70 98.80 101.00 9355509
05-03-2018 100.00 102.35 98.70 100.05 4729664
06-03-2018 101.00 102.00 96.75 97.75 3444175
07-03-2018 96.00 96.90 94.10 95.55 4394544
08-03-2018 95.70 97.45 94.35 96.70 3508436
09-03-2018 96.80 97.50 94.95 95.50 2708817
12-03-2018 95.50 96.30 91.30 94.60 3668501
13-03-2018 94.00 102.60 93.30 98.00 8904196
14-03-2018 94.00 100.20 93.35 99.35 7064871
15-03-2018 99.35 101.00 98.00 98.65 4266330
16-03-2018 98.10 102.20 97.60 98.95 4668155
19-03-2018 98.50 100.35 96.00 96.45 2832413
20-03-2018 96.00 97.50 95.25 96.75 1853986
21-03-2018 97.15 99.05 97.15 97.60 1586651
22-03-2018 97.60 97.95 95.65 96.45 1503262
23-03-2018 95.00 95.20 92.70 93.15 2715588

Source:
http://www.moneycontrol.com/stocks/hist_stock_result.php?ex=Bandsc_id=PNB05andmycomp=P
NB

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(An open access scholarly, peer-reviewed, interdisciplinary, monthly, and fully refereed journal.)
International Journal of Research in Economics and Social Sciences (IJRESS)
Vol. 8 Issue 3, March- 2018
ISSN(o): 2249-7382 | Impact Factor: 6.939

Share Value of PNB on BSE from 14/02/2018 to 23/03/2018

160
140
120
100
80
60
40
20
0
21-02-2018

27-02-2018
14-02-2018
15-02-2018
16-02-2018
19-02-2018
20-02-2018

22-02-2018
23-02-2018
26-02-2018

28-02-2018
1/3/2018
5/3/2018
6/3/2018
7/3/2018
8/3/2018
9/3/2018

13-03-2018
14-03-2018
15-03-2018
16-03-2018
19-03-2018
20-03-2018
21-03-2018
22-03-2018
23-03-2018
12/3/2018
Graphical Interpretation:
The above graph indicates that, price of PNB share on BSE has continuously decreased. On 14th
February, 2018 the closing price of PNB share was Rs.145.80 and on 23rd March, 2018 price fell
up to Rs.93.15. The share price of PNB is decreased up to 36.11% in one month (from 14.2.2018
to 23.3.2018) due to scam of Mr. Nirav Modi.

Generic Observations:
The following are the generic observations applicable to all kinds of banks’ scams (BOM, PNB,
IDBI etc.), PNB Scam discussed in this paper is not an exception to these Generic Observations.
1. Generally, the transfers of bank employees take place after every three years. But it is
found that the transfers of the employees involved in the scam do not take place for many
years. (In case of PNB the transfer of the bank employees who were involved in the scam
did not take place for more than seven years)
2. Corruption comes from the top and it percolates till the bottom. Hence, employees at the
middle level and lower level do not deny or take any action against wrong doings in the
system.
3. Few employees may not be aware about bad practices prevailing in the system. Few may
be aware about the same but they ignore the same as they perceive that it is going on
regularly since long back. Few employees will be involved in the scam as per the direction
of higher authorities. They knew that nobody will take action against them as they will be
backed by higher authorities, if required.
4. Banks do not show actual NPA. Hence, later on scams may take place. Many branches are
giving new loans in order to recover old loans from the amount of new loans to avoid NPA.
Basically, without recovery of old loan, new loan should not be sanctioned and disbursed.
But, it is not happening in practice in many banks. Crop loans and loans given to the giant
corporate are the best examples of the same.
5. There is scarcity of willingness to implement proper systems, rules and regulations for
transparency because of which scams are indirectly encouraged.
6. Employees who want to work as per the rules and who don’t want to get involved in scam
are either transferred or disciplinary actions are taken against them, out of malice.

International Journal of Research in Economics & Social Sciences 325

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(An open access scholarly, peer-reviewed, interdisciplinary, monthly, and fully refereed journal.)
International Journal of Research in Economics and Social Sciences (IJRESS)
Vol. 8 Issue 3, March- 2018
ISSN(o): 2249-7382 | Impact Factor: 6.939

Conclusion:
With respect to Banking Sector:
The Net worth of the PNB decreased and it will continue to decrease further. As a result, its Book
Value and Marketing Value per Share will also decrease.
With respect to Investors:
PNB scam has started showing its bad effects already. Market value of PNB per share is decreased
by 36.11% during the period of 14.2.2018 to 23.3.2018.

Recommendations:
1. Ministry of Finance and RBI should take strict action against the PNB officials, responsible
for the scam immediately.
2. PNB should block all the accounts of concerned persons and take custody of all assets of
defaulters of PNB immediately to create the confidence among the investors.
3. Government should take care of the investors. PNB and Government should change the
Board of Directors and Auditors of the bank. Also they may appoint an ‘Official
Administrator’ to regulate and control present important banking transactions.

Bibliography:
1. Buyer's Credit. (n.d.). Retrieved 03 05, 2018, from www.investopedia.com:
https://www.investopedia.com/terms/b/buyers-credit.asp
2. Letter of understanding. (n.d.). Retrieved 03 05, 2018, from en.wikipedia.org:
https://en.wikipedia.org/wiki/Letter_of_understanding
3. PNB Scam: Effect on Mutual Funds. (n.d.). Retrieved 03 05, 2018, from https://groww.in:
https://groww.in/blog/pnb-scam-effect-on-mutual-funds/
4. WHAT IS PUNJAB NATIONAL BANK’S LOU FRAUD? (n.d.). Retrieved 03 05, 2018, from
www.indianeconomy.net: https://www.indianeconomy.net/lms/economy-
news/punjab-national-banks-lou-fraud.html/

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