PNB might become first bank to get 'defaulter' tag in 5 days

• Total exposure of Indian banks in the alleged fraud is approximately Rs 20,000 crore
• Axis Bank has an exposure of Rs 20-30 billion, Allahabad Bank has Rs 40 billion and SBI, Rs 13 billion.
  
• As a result of the scam, the Reserve Bank of India (RBI) decided to ban LoU-based transactions on March 13.

Punjab National Bank (PNB) has five days to honour its guarantees to the Union Bank of India to the tune of Rs 10 billion. If it fails to do so, Union Bank, in an unprecedented move, will have no option but to consider PNB a defaulter in its books and may even have to classify the unpaid amount as a non-performing asset (NPA) based on the recommendations of its auditors. Both banks are state-owned and if this default happens, it could shake the foundation of the banking sector leading to both the people and international banking institutions losing faith in the banking system. The only way this can be avoided is if the government or the RBI swoop in and bail PNB out.

All this stems from the Nirav Modi case which involves fraudulent letters of undertaking (LoU). And though this matter is being investigated by government agencies, Union Bank contests that there is no fraud in its books. Rajkiran Rai, MD of Union Bank told the Economic Times, “For us, it is a genuine claim on PNB backed by documents. It is not a fraud in our books... We will take the auditor’s view. However, we don’t want to list PNB as a defaulter. We are expecting some intervention from either the government or RBI so that there is a resolution by March 31.”

LoUs are essentially a tool used between Indian banks as guarantees under which customers of one bank can raise money from the other Indian bank's foreign branch in the form of a short-term credit arrangement, typically 90 days long. In the case of Nirav Modi and Mehul Choksi scam, the total exposure of Indian banks in the alleged fraud is approximately Rs. 20, 000 crore--almost twice the initial estimate. According to Business Standard, apart for Union Bank of India, Axis Bank has an exposure of Rs 20-30 billion, Allahabad Bank has Rs 40 billion and SBI, Rs 13 billion.

As a result of the scam, the Reserve Bank of India (RBI) decided to ban LoU-based transactions on March 13. However, this move has raised concerns with a bunch of bankers. Asked if the RBI decision is an overreach action by the Economic Times, the Finance Ministry's Principal Economic Advisor Sanjeev Sanyal said, "I am not in a position to comment on RBI decision they have just introduced… But, the general point remains that you have to take a nuanced view of these things in particular because you are not dealing with a silo system. You are dealing with an inter-connected ecosystem and if you block off oxygen in one part it rapidly spreads to rest of the system.”