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Can Digital Lending avoid the making of any future Nirav Modis?


All about the fraud

On February 14, 2018, another massive fraud took the Indian banking industry by storm when Punjab National Bank, the second-biggest state-run lender announced that it had discovered fraudulent transactions worth 11,400 crore rupees ($1.77 billion) at a single branch in Mumbai. The alleged parties were none other than the famous (or now the infamous) diamantaire Nirav Modi, whose diamonds have sparkled on the celebrities walking on Hollywood red carpets, and Mehul Choksi, the managing director of Gitanjali Gems.

This fraud has exposed the working culture of public sector banks which are becoming vulnerable pickings for big corporate houses. It has also questioned the legitimacy of the loan approval and servicing process by the banks and brought into the light, the inefficiencies of lending when proper technologies are not put in place.

What went wrong!

The PNB made serious lapses in implementing the rules and following the laid procedures of banking which allowed the alleged companies to concoct multi-crore frauds.

Issuing LoUs: While issuing the high-value LoUs (which serve as a guarantor for drawing funds from a foreign branch of the lending bank) in Modi-Choksi case, PNB did not follow the basic rule of getting the LoUs vetted by officials of higher management in the issuing bank. The LoUs did not have any credit limit and Modi was also not asked to pay margin money (a certain amount of money as a guarantee to PNB, as this bank was issuing the letter of undertaking). Moreover, the other banks that were sent these LoUs believed in the authenticity of it since the promise was coming from a nationalized and trustworthy bank and happily released the funds.

SWIFT transactions: When the LoUs are sent to the foreign bank through SWIFT(Society for Worldwide Interbank Financial Telecommunication), there is a hierarchy of people involved, however, in PNB, only one single person of below the expected rank acted in two capacities.

CBS Systems: The SWIFT transactions are done through the core banking solution (CBS) system, which records all the transactions of all such customers for all bank branches that are involved in the process. In this case, the bank officials who were involved in fraudulent LoUs bypassed CBS for the Modi-Choksi LoUs.  And astonishingly, the department or any auditors failed to take note of this delinking for nearly 7 years.

The role of technology

As on 30 September 2017, data from CIBIL shows that in the banking system, 83.6% of all the outstanding amount on account of willful defaults is with the nationalized banks. In the past, banks such as Bank of Baroda, SBI were found lax in implementing banking rules to protect their interests against defaulting business houses. According to a Reserve Bank of India (RBI) report, sourced by Reuters through an RTI, state-run banks have reported as many as 8,670 "loan fraud" cases totaling Rs 61,260 crore over the last five financial years up to March 31, 2017. Since the reasons for banking fraud can be aplenty, there is no “one silver bullet” to stop all frauds forever. However, by leveraging the power of digital technologies, banks can detect fraud sooner and mitigate the negative impact of significant losses occurring due to fraud.

Digital Lending

Experts have called for an overhaul of the banking system saying that there are several loopholes in it. With the advent of digital technologies such as cloud etc., Lending has seen a paradigm shift. There needs to be a system that understands a lender’s requirement and can mitigate such credit and operational risks. The verifications that such a platform provided by integrating with some of the most sophisticated data providers goes beyond traditional verification.  Even when the loan is funded, services such as cash flow monitoring and credit monitoring of the borrower acts as an icing on the cake that helps the lender to expedite the fraud detection and thus prevention.

Could Blockchain have “blocked” this fraud?

The blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value. If blockchain technology was used for transactions and accounting, the fraud at Punjab National Bank (PNB) could have been prevented or at least detected earlier, say fintech experts.

Comprehensive Auditing via Smart Contracts: In this case, the smart contracts would have been designed in such a way that any transfer could not have been made without the approvals from specific people. This would establish a clear chain of command, a clear accountability and a clear audit of all the people involved in the process and thus funds movement would not have happened without their knowledge and approval. Smart contracts would have identified inconsistencies based on automatic reconciliation with core banking system and following the established limits, it would have restricted the payment initiation over SWIFT network.

A few banks in India have already started testing the waters with blockchain. These include ICICI Bank, South Indian Bank of India, State Bank of India and so on. According to a press release on SWIFT’s website from October, it said that "tests show blockchain has a potential for global liquidity optimization."

SWIFT-CBS: If the entire system had been on the blockchain, there would be no question of the SWIFT system and the CBS being out of touch with each other. So, unless the bank had the funds and it showed up in the system for all to see, there would not have been an LOU or SWIFT.

Power of Data and Analytics

Banks operate in both B2B and B2C modes and hence have a vast amount of data. Banks should adopt appropriate technologies that include a mix of strong authentication systems with aid of analytics which can help in continuous fraud prevention and safeguard organizations from fraudulent activity.  While the use cases of Machine learning are galore in the banking domain, in the realm of fraud detection, its power can be harnessed is to help build robust system which becomes intelligent enough to detect specific patterns and relationships that can be used to discover a fraud scheme at a nascent stage. It can also automate compliance reviews which means it will ensure increased customer screening and enforce adherence to the laws.

The way forward

The banking sector is groping with challenges of frauds across the world. Looking at the series of bank frauds in the past decade, Indian banks are probably way behind in the preparedness in fraud risk management. Our banking software needs to be more robust which can identify the inconsistencies in transactions and act as a deterrent to such frauds. This is possible when the banking systems integrate with the new age start-ups that provide a technologically advanced platform for digital lending.

  • March 1, 2018
Neha Bhargava
Neha is an Associate Product Manager with Lendfoundry and she is responsible for Product Roadmap, strategy, and implementation. She has over 8 years of experience in IT product companies. She is passionate about building products. She joined Lendfoundry after completing her MBA from IIM Calcutta. She can be reached at

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