Fugitive Mehul Choksi's Arrest Highlights Need For Tighter Regulation

Choksi has been on the run for the past seven years. He and his nephew, Nirav Modi, are wanted in a fraud case involving a loan of over Rs 13,500 crore from the Punjab National Bank (PNB). He obtained an Antiguan citizenship in 2019, but landed in Belgium a few months ago, reportedly for cancer treatment.

This brings to focus a sizeable list of high-profile bank and financial fraud cases in India during the last decade or so. All these involve thousands of crores of rupees, and expose existing systemic weaknesses in banking and financial oversight, risk management, and regulatory controls.

The economy has lost a substantial amount of money, and most of the time, the loss is borne by the banks. The loans involved in such frauds and scams are more often than not provided by public sector banks.

Banking Scams & Frauds In The Last Decade

The Nirav Modi-PNB scam came out in the open in early 2018. Celebrity jeweller Nirav Modi and his uncle Mehul Choksi took the help of corrupt PNB officials and fraudulently obtained Letters of Undertaking (LoUs) without proper collateral or recording them in the bank’s core system.

LoUs are bank guarantees used for overseas credit. The duo managed to secure more than 1,200 fake LoUs over several years, enabling them to siphon off more than Rs 13,500 crore (about US$ 2 billion) from PNB and other Indian banks.

Collusion with bank insiders kept the scam undetected for years. There were also manipulations of the SWIFT messaging system, and systemic auditing failures. Through overseas shell companies, the funds were laundered and rolled over repeatedly, to disguise the mounting debt.

When a new set of bank officials demanded proper collateral, it led to an internal investigation and subsequent complaints to the CBI and the ED. Both Modi and Choksi fled India before the scam was unearthed. Modi was later arrested in the UK, with extradition proceedings going on.

Earlier, in 2016, Vijay Mallya, once a mercurial businessman and owner of Kingfisher Airlines, defaulted on loans worth around Rs 9,000 crore that were borrowed from a consortium of Indian banks, including the State Bank of India (SBI), PNB, and others.

Kingfisher Airlines was launched in 2005, but in a decade, it became financially unviable. To keep it afloat, Mallya secured more large loans by cooking up financial projections and offering personal guarantees.

Later investigations showed that a substantial portion of these loans was diverted to personal accounts, other businesses and luxury expenditures. The airline collapsed in 2012, and the loans turned into non-performing assets.

As investigations were initiated, Mallya fled the country to the UK in 2016. His extradition proceedings in the UK are ongoing.

Non-Banking Sector Not Immune To Scams

These lapses are not exclusive to the banking system alone. Even non-banking financial companies (NBFC) are not immune to all these lacunae.

In 2018, the IL&FS (Infrastructure Leasing & Financial Services) scam unfolded in the NBFC sector. IL&FS, a major infrastructure finance company, had concealed its bad loans and financial troubles for years, by manipulating accounts and misreporting.

Then it defaulted on repayments, while the total liabilities of the group amounted to over Rs 91,000 crore. This triggered a liquidity crisis in India’s financial system. Subsequent investigations revealed mismanagement, money laundering and collusion with auditors.

The government had to step in to take over control, which resulted in a complete overhaul of the company’s management.

In the very next year, the DHFL (Dewan Housing Finance Corporation Limited) scam involved fraudulent diversion of over Rs 34,000 crore borrowed from a consortium of 17 banks.

The promoters created fake loan accounts and shell companies to siphon off funds by manipulating government housing schemes and laundering money. This turned into massive losses for the banks, and further erosion of trust in the financial system.

The promoters of DHFL were arrested, and legal proceedings against them are going on.

Economic Impact Lessons From Last Decade

Any bank or financial fraud results in the removal of precious but scarce financial and industrial credits from the economy. It impacts not only banks but also investors and depositors, as the government bailouts after these scams are done using taxpayers’ money.

Needless to say, loss of funds also leads to a rise in non-performing assets (NPAs) in the balance sheets of the banking system. Immediately after such fiascos, stock markets show volatility, showing destabilising effects of these financial frauds.

The banking system also undergoes a loss of reputation, trust, and investor confidence — making it harder to attract domestic and global investment in the immediate future.

Policy Lessons From Last Decade

At the macroeconomic level, financial frauds immediately result in a loss of revenue and a rise in fiscal deficit in the next period. This, of course, dents the country's GDP trends and developmental goals. Indirectly, these also lead to economic and social inequality, as the poor and middle classes bear a disproportionate burden of replenishing the lost funds.

If any lesson needs to be learned from these scams, it is the supreme requirement of greater financial vigilance. In a system prone to corrupt practices, "on-the-shoulder regulation" for all banking and non-banking financial entities is a must to prevent the occurrence of these frauds and scams.

Apart from strengthening the RBI and SEBI as the regulators, there is a need for digital vigilance in today's times. A top finance ministry official said, "Artificial Intelligence (AI) brings a lot of risk, but it can be used for real-time transaction monitoring and fraud detection as well."

"However, conventional methods like regular auditing and the introduction of a robust whistleblower programme are time-tested methods to prevent fraudulent activities in banking and non-banking sectors," added the official.

The occurrence of frequent financial scams also demands dedicated fraud detection teams both in banking and NBFC systems.