Ok. I will do my own little explainer since I found the usually excellent @andymukherjee70 a little light. Usual caveats apply. This is based on my knowledge of how banks and LoU's work. This may not be how the real fraud happened
LoUs issued to foreign banks or branches are almost always sent through SWIFT. SWIFT is a messaging system. A bit like WhatsApp for banks
Banks use specific codes to identify types of transactions. Eg: MT760 is for Bank Guarantees or standby letter of credit.
PNB would send a SWIFT message with an MT 7XX code to other banks saying that they backstop those banks to the extent of the amount in the message
Based on this, banks can further lend money as per the terms of the SWIFT message that PNB sent. Since it is an authenticated message from a bank, this is treated as an instruction to the receiving bank.
Feeling secure that PNB has backstopped a particular amount of funds, the receiving bank now opens Buyers Credits/ discounts bills (basically lendssl money to client)
Brief digression into the jewellery business. Jewellers buy and sell gold and rough/polished diamonds.
Rough diamonds are polished and then sold back in the international market. Surat is a global centre of polishing and cutting gems.
Rough diamonds are a very expensive raw material, and cutting and polishing form a very small percentage of the cost of a diamond
So a diamond that costs 1000 dollars would probably have only about 20 dollars of cutting and polishing costs associated
Cost of transporting diamonds is also relatively low because of its high value to weight ratio. This makes diamonds a very attractive tool
An attractive tool to misuse funds via fake invoices. Banks lend money in USD which is lent at low rates. Indian firm uses these low cost funds for working capital / speculation
Jeweller in India generates return of 10% on funds that cost him 4%. Two months later buyers credit is paid off and the extra 6% is shared between importer and exporter
Back to the PNB case. So the PNB LOU is used by banks to lend money to entities. These entities invest the money in India and pay back BCs and everyone wins.
Until the entities stop making 10% returns....especially if your way of generating returns was to put it in the stock market.
If your bad luck is good, and you lose the money that you claimed was used to buy diamonds, you are up shit creek with not much of a paddle
At which point you go to PNB to lend you more money. And use that money to make more money...and then pay off your loans
But some PNB banker checks that you don't have approved facilities. Now wait....how were the Swift messages sent without facilities in the first place?
That's because SWIFT is WhatsApp for banks. It doesn't have a link with core banking systems that check for lending facilities and stuff by default.
It depends on manual checks done by the swift inputting dudes. Which seem to only have been done in Jan
So now PNB realised that a whole bunch of LoUs have been sent to other banks with no underlying credit limit sanctions
Which is where we are today
