Non-Recourse Borrower Dependent Promissory Note: Fill & Download for Free

Over last few days, the Nirav Modi-PNB scam is rocking news headlines in all media including social media, and, some hilarious while some serious pieces of words are doing rounds. Too much going through this kind of stuff leads one to depressing thoughts and loss of hope in the institutions of this great nation.I have tried to do some analysis here to put things in perspective. This is my assessment of the situation, I may, or may not be correct, but, in all probability based on my experience I feel I have a fairly good chance of being correct. As time will tell in next few days, whether my assessment holds good or not ?To begin with, let us understand the concept, banks issue instruments such as letters of undertaking, letters of credit, bank guarantees, letters of guarantees and so on based upon the request of their clients, to carry out transactions in imports business/access funds from foreign banks. There is also another concept of solvency certificate, which is non-binding and without any financial liability on the part of the issuing bank. However, all other instruments mentioned here-in-above are kind of promissory notes and equivalent to cash to be paid upon demand/on expiry or on default of the client.Banks generally obtain cash margin plus collateral security of immovable property to cover their risk against such guarantees issued to the clients. Moreover, the balance sheet of the banks will never tally if such guarantees are issued without adequate cover, of course there is a mismatch to the extent the value of collaterals offered against such guarantees are over-valued, but, still on paper it will appear to cover the banks risk in case of eventuality of default of client to pay up the sum of such guarantee. Another important aspect of such instruments is that they all expire on a fixed date from the date of issue; it could be any time between 30 days to 360 days. Once expired, such instruments will have no value.The client based on this guarantee obtains access to funds from foreign banks or Indian branches of foreign banks at international rates, which are far lower than as applicable in India. The foreign banks give funds to the client against such instrument at LIBOR (London Inter-Bank Offer Rate) plus interest rate, giving the customer an opportunity to borrow cheap from international market. The original guarantee/undertaking as and when is likely to expire, the bank which has granted funds to the client, will ask for repayment from the client, and if client defaults on due date, will enforce Letter of Undertaking with the issuing Bank and the liability of issuing bank is crystallized in that case, and they have to recourse to the cash margin plus collateral of the client taken at the time of issuing LoU, to recover their payment obligations to the foreign bank.Such transactions are carried out on real time basis and it is reflected on the Nostro & Vostro accounts of the issuing bank as well as lender bank.With this background, let us try to understand what could have happened in the case of Nirav Modi. They have been obtaining Letters of Undertaking from Punjab National Bank since 2011 to 2017. Each LoU will have a fixed expiry date, as the liability of bank cannot be for indefinite period in perpetuity. Accordingly, the total of 11,400 crore has emerged, which is the total value of Letters of Guarantee which PNB has issued to Modi & Chokshi group of companies. The impression which is being given from media reports is that, this is the total outstanding amount of guarantees of PNB and as and when this liability crystallizes the bank is supposed to pay this amount to the foreign banks/foreign branches of Indian banks. This is highly erroneous conclusion. I will try to explain this with an example of why this is not possible. The guarantees which were issued in 2011 depending on the number of days for which they were issued would have ended within the same year or 2012, the client had 2 choices than, either, liquidate the outstanding of foreign bank or provide them with freshly issued guarantees, in either case, the old liability of PNB would have subsumed by new letter of undertaking, albeit with a higher amount, if it was to take care of the principal plus interest accumulated, but, in any case, totalling the amount of previous guarantee plus the new one will lead to erroneous conclusion of outstanding liability. Further, if client did not pay against the advance obtained against first LoU or replaced it with new LoU, the lending bank would have enforced their claim with PNB then only and things would have come to the forefront. However, since this did not happen, I am assuming that the repayment or replacement of first LoU did take place with the foreign lender at that point in time. Now, this cycle started and continued till 2017, in collusion with the officials of PNB, every time the previous LoUs expired, since Modi/Chokshi didn’t want to pay, they provided foreign lenders with freshly issued Letters of Undertaking from PNB. So the total liability of PNB as on date will be the Letters of Undertaking against which the fraudsters have borrowed funds plus accumulated interest thereon. If there are other foreign branches of Indian banks who have discounted the LoUs issued by PNB and provided funds to Modi/Chokshi, they have no cause of worry, because ultimately they will be reimbursed in full by PNB.As regards PNB, with over 60000 crores in NPA, another few thousand crores of losses (not 11,400 crores but much less), is definitely not going to make things any worse than what it is.Now, let us examine how the things came to limelight in 2018 and not before. The cycle went on without any abruptions till 2017, as long as there were colluding officials in PNB, who issued Letters of Undertaking upon demand to the client against inadequate or may be very poor coverage. The clients when approached the PNB in 2018 to provide foreign lenders with fresh set of Letters of Undertaking so that they can roll-over their debt repayment obligations, the new staff, demanded full security against issuance of fresh LoUs, the employees of clients spilled the beans, that they never provided any additional securities to get such guarantees issued and thus, the investigation took place and PNB realised that they have issued guarantees without any cover to fall back upon, in case of default by clients and things appeared in the limelight.The number of 11,400 crores in all probability is misleading and the magnitude of the scam may not be this high. This is the total amount of Letters of Undertaking (LoUs) issued to group companies of Nirav Modi and Mehul Chokshi over a period of 7 years from 2011 to 2017 by PNB. Much of this would be to roll-over the previous outstanding LoUs upon expiry.The transactions which happened in this case are routine in business practice and is being widely used across the spectrum in international business. Things went out of control for the promoters when they could not roll-over their obligations and greed overtook morality thus, the fraud happened. The institutions could not detect the fraud earlier because the entries were not made in the core banking system by the corrupt staff entrusted with the responsibility to protect public funds.The investigative agencies are on the job, soon the actual number of outstanding liability on PNB will be known, there will be some assets belonging to clients, which will help recover the losses of PNB and actual hit on PNB will be far less than what is being propagated.