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After the PNB Fraud in which over Rs  11400 crores are suspected to have been lost came to light, many other frauds are slowly tumbling out the closets of E Banking.

Leaving aside the fact that the lenders of different Banks who lent money to Mr Nirav Modi and Mehul Chokshi failed to check the “End Use” of funds and allowed renewal of LOUs without checking the previous utilization and need for extension, it was also realised that PNB had even allowed the Nirav Modi employees to directly access the SWIFT messaging system of the Bank.

The system of the Bank was so configured that SWIFT system could be accessed from outside the banking network. The operating officials of the Bank gave away passwords of multiple officials  to the Nirav Fraud team.

The system had no control that could detect that the log in was from outside the Bank’s network, multiple passwords were entered from the same computer and the messages did not reflect in the CBS system, nor created vouchers for commission or margin collection.

This was a gross failure of the Bank staff and the information security configuration of the systems.

It is true that any IS control can be defeated if the employees are dishonest. But still, the system design should be such that even if some of the employees are dishonest, the fraud should be detected, if not for the first time, in subsequent times.

Unfortunately the creators of the software in Infosys who sell FINACLE and supply it to a number of Indian Banks, are not aware of the intricacies of Banking transactions and how frauds could be committed. Hence their design is a faulty design and Banks are saddled with this defective product.

Now yet another fraud has come to the open in State Bank of India, Chennai where also it appears that the passwords of the Bank staff has been used by an outsider to divert over Rs 3.2 crores of money (Refer article here) meant for purchase of Cars as an unsecured cash advance which was used for funding a Film production. Here again, the security configurations of the CBS software has failed to recognize that Cars were not purchased, money was not credited to a Car dealer’s account, documents such as RC book etc was not submitted, asset inspection did not take place etc.

In all such cases, it is clear that it is not only the Software that failed, but also the internal audit system.

It is high time that Indian Banks rethink on how their “Internal Auditors” are equipped to conduct audits in the Computerized environment.

If internal audit cannot identify this new generation of Bank frauds where the customer himself is given access to the Bank’s systems to design his own loan sanctions, create approvals of several layers of bank officers and take the money out, then there is no need for such audits.

Where such “Self Loans” are used in the “Kite Flying Mode” and repaid with a roll over loan, it is very difficult for normal audit processes to find out the anomaly. There is definitely a need for Computer Assisted Audit techniques either with in built features of the core banking software or through specialised audit tools.

FINACLE Strengths and Weaknesses

The Banking software like FINACLE which costs a fortune for the Banks should have an inbuilt, non-tamperable audit module that should be effective in preventing such frauds to continue beyond the first couple of occurrences if not the first time.

FINACLE boasts of an Audit module as part of its system but it is clear that it has failed in the context of not only PNB Brady Branch but also SBI Chennai branch and in the many other similar cases that have come to light now.

If the Indian Banking system is in doldrums today, a large part of that responsibility should be boarne by the CBS software suppliers who have supplied defective products to the industry.

RBI has failed to subject the software itself to an audit of IDRBT which is mandatory and hence part of the responsibility for the use of defective software lies on the RBI also.

While checking on the Audit capabilities of FINACLE, I came across an article describing the audit capabilities of FINACLE.

Some key FINACLE menus and their use for an auditor has been described in this article. Some of them are briefly reproduced here.

  1. Account Leger Enquiry (ACLI)
  2. Customer Account Leger Print and Office Account Ledger Print (ACLPCA and ACLPOA)
  3. Audit File Inquiry (AFI)
  4. Average Balance (AVGBAL)
  6. Customer Master Inquiry (CUMI)
  7. Report on Expiring Documentary Credits (DCEXPLST)
  8. Query on Documentary Credit (DCQRY)
  9. Exception Report (EXCPRPT)
  10. Generate Report (GR)
  11. Financial Transaction Inquiry (FTI)
  12. Accounts Due for Review (ACDREV)
  13. Inward/Outware Remittance Maintenance (IRM/ORM)
  14. Outstanding Items Report (MSGOIRP)
  15. NPA Report (NPARPT)
  16. Letter of Acknowledgement of Debt Report (LADRPT)
  17. Loan Overdue Position Inquiry (LAOPI)/Ttemporary OD Report (TODRP)
  18. Print Reports (PR)
  19. Guarantee Issued Liability Register (GILR)
  20. Partywise Overdue Packing Credit (POVDPC)

The above list indicates that there should have been several reports that should have thrown up audit queries in respect of PNB Fraud as well as the SBI Fraud.

Now what we need to check is why did the discrepancies were not thrown up by the audits?

The reasons could be many.

  1. First reason could be that no audit was at all conducted. In PNB we are told that RBI did not audit the branch for more than 9 years. It is not clear if the internal audit was also bypassed. If so was there any declaration in the annual reports to the share holders providing the list of branches which were not audited for the last 1/2/3 or more years?
  2. If an audit was conducted, it is possible that the auditors were not aware of all these modules andhow to use them appropriately
  3. Perhaps there was lack of adequate training of  the auditors.
  4. It is also possible that FINACLE comes with some base module that does not include all features and a higher priced module that may include additional modules and the Bank could have not taken the full module for cost considerations.
  5. It is also possible that the FINACLE system itself might not be able to properly analyze the data in the above modules though it may create some printable reports.

Need for Data Analytics in Audit process

Computer Assisted Audit Techniques that are essential for proper auditing of any Computerized data environment requires a capability to

a) Acquire data of different types from across the network available in different platforms and collate it into a common platform for analysis

b) Extract, Classify and Re-classify data into different groups which create new meanings not visible in the direct report

c) Search data across multiple categories and filter them against some specific risk identifying algorithms

d) Use known statistical methods such as Benford law to check on potential frauds

e) Use Forensic audit tools to discover evidence that has been buried by the fraudsters

f) Use “Checking of Controls” as a part of the audit including the Information Security controls such as “Access Control”, “Log Analysis”, “Incident Management System” etc.

It is clear that the current Internal Audit process in Banks is not equipped to conduct an audit outside what reports are submitted by the Branch to the auditor. If the Auditor audits only what the auditee wants him to see, then the value of such audit is low. Perhaps it is what statutory auditors do. But Internal auditors have to go beyond checking the arithmetic accuracy of the transactions and go into an in-depth fraud possibility analysis.

Cost and Training Hurdle

In examining the solutions that the Auditors could use, it was observed that the tools normally considered as reputed “Computer Assisted Audit Tools” or CAATs are prohibitively expensive and require a rigorous training both of which seem to create a hurdle for Banks.

However, it is possible for RBI to equip itself with such tools (ACL, IDEA, ARBUTUS etc) and use it in its audit as a starting point. Other Banks may start using it depending on their size. Obviously the larger Banks donot have any constraint on budget nor ability to train the auditors, But smaller Banks may have a problem.

I therefore suggest that smaller Banks create a “Technology Resource Pool” in a “Centralized Fraud Investigation Center” which should be equipped with such tools and talent and conduct audits of member Banks as a service.

I hope RBI will take such steps to ensure that in future the audit system is strengthened to such an extent that the frauds such as what we are now seeing does not go undetected before it balloons into a huge scam.


(P.S: I have been an ex-Banker and therefore may not be fully aware of the current situation in the Banks about how audits are conducted in the Computerised environment.

But looking at the frauds that are surfacing, it is clear that the system is not working properly and hence some of the observations made above may be true though I may not be able to give evidence of the same. If we want to clean up the Bank system, Bankers need to do a self evaluation of their systems and check if some of the points made here are relevant or not.

I invite comments and suggestions on how to improve Audit systems in Banks in the computerized environment… Naavi)

RBI is making a mistake in the PNB fraud case

Posted by Vijayashankar Na on February 15, 2018
Posted in Cyber Law  | Tagged With: , , , | 1 Comment

As expected, media is crying as if Rs 11500 crores have been lost by PNB. Congress as expected is talking as if it is not Nirav Modi who is in question but Mr Narendra Modi himself. Both may be excused for their ignorance and need for TRP.

However, I am surprised that RBI has come out with a statement which is in my opinion legally incorrect.

Normally when letters of guarantee are issued, they are issued on stamped papers and with an understanding that the beneficiary will be “Paid without demur”. RBI is therefore saying that PNB should pay all the liabilities without contesting.

However , PNB Chairman has rightly stated  in his press conference that the bank would repay only bonafide claims.

I fully agree with the contention of PNB that they should not make payment blindly to anybody who makes a claim as beneficiary of the guarantee. They should challenge the claim since there is a “Notice of Defective Title” to the beneficiary and PNB is bound to exercise caution.

In this case, the lenders are supposed to have financed some valid business proposition with the letter of comfort as a collateral security. No Bank is supposed to treat a letter of guarantee as just an endorsement of a cheque and make payment just like that. If after this the venture fails for some reason and the cause of action for which the letter of guarantee was issued arises, then only the guarantee can be invoked and the issuing Bank is obliged to pay.

If the beneficiary is Nirav Modi’s own firm or there are other reasons for which the transaction for which the lender disbursed money was not justifiable for business purposes, then the transaction is prima facie suspect and the beneficiary himself can be considered as an accomplice to defraud PNB.

The forged letter of undertaking should be considered as a “Nullity” and not an “Authorized instrument that can create liability”.

If PNB can prove that the beneficiary had reasons to believe that the transaction is suspicious, then PNB would not be liable to pay.

Share holders of PNB should therefore object to RBI’s instructions which is meant to protect the other Banks which actually had a direct contractual relationship with Nirav Modi’s beneficiaries while PNB itself is a victim of the fraud committed by its own officers.

We can accuse PNB of negligence but it is for another day and for another argument . It does not give license to other banks to accommodate Nirav Modi beyond his genuine business requirements and claim protection under the guarantee. The Guarantee would be valid if the beneficiary had taken the decision to lend as if there was no collateral in the form of the guarantee.

Further PNB should immediately revoke its guarantee and if there is any claim by any beneficiary, the beneficiaries may be asked to raise their claims with full particulars of how the lending decision was taken. It can then evaluate genuineness of the claims and decide the course of action.

At this point of time we donot have the actual text of the document and hence we donot know whether it was transferable and could be discounted with secondary lenders or whether any transfer was required to be registered with the PNB, whether there was a time limit for validity and the claim, etc.

I suppose the press will get these details shortly but RBI should let PNB handle its liability without jumping in to protect other Banks like Allahabad Bank or State Bank of India.

If the liability gets divided with 30 Banks it may be fine. No single Bank will take a big hit. In future RBI should insist that the beneficiary should register his claim within a reasonable time after the guarantee letter is submitted to him and that would avoid situations like this.

The Swift system should provide for digital signature of such transactions and the digital signing should be registered automatically in the Core Banking System so that frauds like this cannot happen. Finacle as a CBS software should integrate the Swift messages with the CBS so that every SWIFT message is generated from within the Finacle system and duly recorded for audit at the Central office level

Since it is stated that more than Rs 6500 cores worth assets have already been confiscated, and the lenders will have additional securities available to them, a substantial part of the actual losses may be fully recovered.

Hence neither RBI nor the media need to sensationalize this scam. The officials however need to be punished for the fraud.


PNB Fraud of Rs 11500 crores was waiting to happen.

Posted by Vijayashankar Na on February 15, 2018
Posted in Cyber Law  | Tagged With: , , | 3 Comments

The Rs 11500 crore fraud in India in Punjab National Bank (PNB) was a fraud which was waiting to happen due to the negligence of the Bank and the software developers supporting the Banking operations.

It appears that those who developed the Core Banking software for the Bank had no understanding of the nature of controls that were required to prevent misuse of “Non Funded Lending”.  If money goes out of a lending transaction, it might be captured by the system. But when only a “Letter” goes out “Undertaking a liability to pay contingent to an event of default by a customer”, it may not get into the books until the liability fructifies.

If the liability does not fructify and the letter is issued for a period which lapses, no problem arises to the Bank except for the opportunity loss of a “Commission”.

Such activities lend itself to “Kite flying” frauds which is what has happened in this case. In the past the Harshad Mehta Scam.was in similar mould. Even the Satyam Computer fraud was also of the same nature. In all these cases, certain false papers were floated around on the basis of which another third party lent funds. When such kite flying frauds miss a repayment cycle, it would snow ball into a major scam with a casacading effect.

It is ironic that the name of the fraudster is Nirav Modi and the Congress would be happy to use the occasion to place the blame on Mr Narendra Modi as if Rs 11500 crores has gone to his pockets. Mr Rahul Gandhi who is an expert at spreading falsehood will soon start speaking about this fraud in the Karnataka elections. It would not help if Mr Nirav Modi has left the country and is absconding.

Compared to Mr Vijay Mallya’s case which appeared to be caused out of a business  failure of the companies of Mr Mallya, this fraud is of a more criminal nature since it involves “Forgery” of a document in the name of PNB.  Hence the kind of protection Mr Mallya may get from international legal processes for not forcing his return to India may not hold for Mr Nirav Modi. Once he is located, he can be quickly arrested in the foreign soil with the help of Interpol and brought back to India.

It is critical for such speedy action to categorize this scam as a result of a “Forgery”. The forgery is because a false unauthorized letter of undertaking has been issued by some of the officials of PNB. Since these letters were issued without proper authorization, they have no legal validity.

Whether the beneficiary of the letter can go behind the unauthorized letter and claim the money from PNB has to be evaluated from the terms of the letter. If the liability arises any time after the public notice of the fraud has been received, then the beneficiary cannot make any claim on PNB.

For the contingent liabilities to fructify, the cause of action should be before the date of publication of the fraud and and the demand should be immediately thereafter.

Whiles frauds using “Contingent Obligations” issued in the name of a Bank or another organization are not new, in this particular case, one can identify the failure of the internal controls of PNB in not properly recording the message sent out of SWIFT undertaking a liability as part of the Bank’s contingent liabilities in the balance sheet.

It is also supposed that no “Digital Signature” was used in the process of signing the letter of undertaking and it was an “Un-digitally signed” letter from the Bank sent out of a system where authentication was based only on password.

This is the failure of the design of the Banking software developed by large companies such as Infosys and used by all major Banks in India and abroad. The software developers only focus on functional aspects of the software and unless there is a domain specialist to assist the developer in understanding the fraud risks, they end up developing software which is not properly designed. The CBS used by PNB is one such software that appears to have not been developed by a proper Techno Banking professional team.

Unless Banks in India and the software companies providing CBS software donot understand the Fraud prevention requirements to be built into the software, we will continue to see more of such frauds not only in the Banking domain but also in other fields.

I recall one of the early software architecture suggestions given by the undersigned to a broking firm where I had suggested control in the form of using accounting principles to track the risks of trading from the placing of the orders to the realization of money from the client etc.  Though it was not implemented, it appears that the PNB fraud would have been caught by such a design.

For the records however, we need to remember that

a) not all of Rs 11500 crores will become a loss to PNB. PNB has to immediately send notices to recall all such undertakings and freeze their operations. They should give notices that these are forged letters not binding on the Bank. If there is any leal fall out arising out of this in international Courts, it should be faced.

b) This is a case of forgery and not a case of business failure like that of Mr Mallya and hence extradition from whichever country Mr Nirav Modi is in is not going to be tough.

c) PNB and other banks should review their software systems to ensure that they capture all contingent liabilities for which there could be a simple solution.

d) RBI should recognize that the failure of PNB and the CBS ( Finacle) as part of their supervision failure.

e) Media should not create false propaganda and fear mongering that Rs 11000 crores might have been siphoned off. Most of these may be in the form of loans against assets and if they are recovered, most of the losses can be recouped.

f) Congress will keep shouting and this should be ignored.

g) The Government should not lose time in taking swift action across the globe and confiscate as may properties of Mr Nirav Modi as possible even before full legal process is initiated.

h) Courts and Anti-National Lawyers should be prevented from placing hurdles in the recovery of money which is of paramount importance now.

If proper action is taken the adverse impact of the fraud can be managed. At the same time proper corrective measures must be initiated for the future. “FINACLE” as a product appears to require a complete overhaul and hopefully the software companies involved must act immediately.