SWIFT – BE LIMITLESS ?

SWIFT, or the Society for Worldwide Interbank Financial Telecommunication, is the world’s largest electronic payment messaging system.

Though SWIFT is associated with electronic funds transfer systems, it doesn’t do any of the funds transfers itself. In fact, it doesn’t even touch money. Remember it is just a messaging system like a messaging system on our phones but a secured one.

So SWIFT is basically just a bank-to-bank messaging system with a standardized language that institutions use to communicate payment instructions and other information to each other.

Electronic Fund Transfers actually move money. But SWIFT messages are used to get information about what needed to happen.

SWIFT comprises of a messaging platform, a computer system to validate and route messages, and a set of message standards.

How SWIFT works

SWIFT uses a system of codes to detail where a transfer is coming from, where it’s going, and how it’ll to get there. These strings of alphanumeric identifiers comprise an institution code, a country code, a location code, and a branch code. It looks familiar because all that is needed to when we do online transfer of funds. And to your surprise when we do NEFT or RTGS it is not the actual movement of funds that takes place but again it is just a message sent from one bank to another to debit or credit their respective account.

It’s worth reiterating that, because SWIFT doesn’t actually send money, institutions that use the network also need banking relationship to move funds.

Each financial institution will have a dedicated SWIFT interface (in other words, a computer-based terminal) on-premises. Most banks set up their SWIFT systems so that they’re isolated from the rest of their networks. (And this is what PNB has been alleging to be the reason for the fraud being gong undetected for years together.)

Bankers can log in to these terminals to manually enter messages. Messages can also be linked with the bank’s computer system and passed on to the terminal. The terminal then sends the SWIFT message to the regional processors in the sender’s country. From there, the regional processor checks, stores, and forwards the data to its operating centre, which passes the message on to the processor in the recipient’s country. That processor delivers the message to the receiver’s terminal, and then sends confirmation. Officials at the respective financial institutions are supposed to audit these to prevent fraud.

Movement of money

Actually transferring funds internationally is a bank matter.

Let us say two customers of the same bank are located in two different countries and want to transfer funds. The customer in country X will ask the bank to transfer funds to the customer in country Z. Branch X will then tell its counterpart what to do via SWIFT. And then it will make the required book entries in its accounting system. That’s it.

But is it that simple? No, it is more complicated and don’t forget there is no one bank only. Many financial institutions are involved here and which send enormous messages including non fund involving messages also!

For example, if one financial institution doesn’t even have a branch in other country, it needs to involve and link other institution in that country to complete the transaction. Both banks maintain accounts at a third institution and they use that third bank to expedite things. They will identify the relationship, send a secure message over SWIFT between the banks, and do a book transfer.

An example of non fund based SWIFT message. Suppose one bank makes a SWIFT message to transfer funds to “N”. But in this message No. 1 the Bank account number is wrong. So the overseas bank sends Message No.2 to originating bank that the bank account number does not match. Then again the bank in India sends Message No.3 intimating the correct account number. You will notice that it is only message No. 1 which is related to funds whereas Message No.2 & 3 are not related to Funds.

Now comes the real part. The message No. 1 MUST be integrated with my banking system, that is common sense! For the simple reason that it involves movement of funds. Whereas, message No. 2 & 3 does not find anything that is related to Funds. While integrating CBS ( Core Banking System ) to SWIFT , the only messages which involve any kind of Fund movement will be necessarily routed through CBS. So the messages which does not hit any Funds may not be necessarily linked to your CBS. So unless there is a regular check on all these kind of SWIFT messages they will remain undetected ! Perhaps PNB might not have even thought that the SWIFT messages which do not have direct involvement of funds will put them in such big trouble !

Now the next question comes is whether LoU’s does not involve any funds then? Yes, they do. Then how come they were not routed through CBS ? Let’s have a deeper look.

A LoU or a Letter of comfort is a kind of undertaking which one bank, say “P” provides to another bank say “O” that bank “O” should give credit to it’s customer say “N”. Now bank “P” will not give such undertaking unless it has some security, correct ?

Bank “P” asks for some security to “N”. “N” keeps some security in the form of say a deposit. Based on this security Bank “P” can request Bank “O” to extend credit to “N”. In case of default by “N” to bank “O”, bank “P” will have to pay bank “O”. While doing so bank “P” will encash or forfeit the security kept by “N” with bank “P” and pay to bank “O”. For doing all this bank “P” will charge some fees to “N”.

So the instances where funds are involved at the end of bank “P” are a) when “N” keeps security with “P” b) when bank “P” charges fees for these services c) when “N” defaults in paying “O” and “P” has to pay “O”.

So “P”’s CBS will be hit only if either of these situations arise ! Imagine a scenario where “P” does take any security, it does not even charge the fees, so obviously these transactions will not hit CBS ! So it clear why the transaction went untraced.

Now let us think about case c) above. In PNB case did Nirav Modi payments to overseas bank ? As per our theory so far he should have. If not then PNB would have been asked to pay and the thing would have got detected. But is it so ? Probably not. There is something more to it.

Let’s understand how things worked.

The Reality: A variation of Ponzi

“N” not necessarily pay back at all. Instead, he asks “ P” to open ANOTHER LoU ( obvious it would again be without security and fees ). This LoU would be for the amount borrowed plus interest.

The money from the second LoU is used to repay the first. It’s just rolling over of credit.

We don’t know the details, but it looks like:

Nirav Modi took loans from foreign branches of Indian banks through an LoU issued by PNB

This was done through a SWIFT based LoU issued through a rogue employee (or many of them) at PNB

The orders never showed up in the core banking system for monitoring

LoUs were rolled over all the way since 2011, and possibly increased over time too.

The rogue official retired in 2017, and the replacement refused to roll over the LoU which came due in Jan 2018 because he couldn’t find the past transactions in the system.

Why couldn’t Nirav Modi just pay it back? He must have the original money no?

Because if it was ever intended to be paid back, the rollovers wouldn’t have been required. At some point, things got so out of hand that rollovers were required in order to stay current.

The SWIFT system was illegally used. (Again, hard to believe that a bank like PNB would not audit its SWIFT messages regularly. Or its auditors. Or RBI.)

Was it possible to do without taking the top officials in confidence. There a separate modus operandi for that. “N” is smart enough to keep the involvements of both the ends (top and bottom ) separate. The staff involved may not even know that TOP end is also involved ( will put a separate article on it ).

AFTER EFFECTS :

1. Erosion on Trust on banking system.

2. Increase in NPA’s : This may create a strong urge in the minds of other borrowers not to repay. ( Interestingly being defaulter in one bank does encroach your right to approach other bank. We have heard of bank official saying low CIBIL score does stop them from extending loans ! )

3. Staff to face the angry and dissatisfied customer which believe me is so difficult that you feel like giving up your job. Even a person who may not have paid a single penny of Income Tax in his entire life will scold you as if you (not the government )have taken his entire life earnings to make good the loss PNB has suffered in this scam. Anyhow trained relationship is not at all healthy.

4. Government or political involvement : Better not to comment on it.

5. Possible bail out package for PNB.

Author :

Shyam P Gwalani.

CA, LLB, GDC&A, MCOM, NET (UGC) , SET , Dip In Cyber Law, Dip in Info Sys Audits ( DISA ICAI ).

(The Author is Nashik Based Financial Consultant.)