Lessons from India’s recent banking scandal…

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Banks and financial institutions are considered the “grease that keeps an economy’s wheels moving” because they lend money to companies who need that money to grow their businesses.

Therefore when there is a problem in a bank, it’s not good for the economy. India recently witnessed a big scandal at Punjab National Bank — owned by the Government of India.

What was the scandal?

Some businesses import (buy from other countries and bring into their own country) gems and precious metals (like gold) and use it to make jewellery to sell in India. When they import it, they need to pay for it in foreign currency (say dollars). So they borrow these dollars from a foreign bank.

To do that, they typically ask an Indian bank to provide a GUARANTEE or a PROMISE that the business will pay the dollars back. If it doesn’t, then the Indian bank will be forced to pay it back.

Hmm… will the Indian bank make this payment to the foreign bank for free? Nope! To protect itself, the Indian bank asks for “collateral” from the Indian business. This is like a house/car/factory. So if the business does not pay the loan back to the foreign bank, the Indian bank protects itself by taking the business’s house/car/factory, and then pays the foreign bank back.

What happened with Punjab National Bank (PNB), is that it made lots of guarantees for an Indian business but did not take any collateral. The Indian business has spent a lot of the money that it borrowed, and says that it cannot repay its loans to the foreign bank. The businessman basically borrowed the money and has not paid it back. PNB is now forced to pay it back to the foreign bank as it had given its GUARANTEE. But it has no collateral from the business! So the full losses have to be borne by the bank. This is the crux of the scandal, because the bank did not correctly follow the rules of banking.

But why would the bank do that? It is thought that some of the bank employees were dishonest and took bribes from the businessman to push through loans with NO COLLATERAL! And this has just been found out.

So how will the PNB pay the foreign bank back? Well, the government owns the bank, so it has to pay the loan back to the foreign bank. And because the government represents us the people, it will be using our tax money to repay the loan. This, in a nutshell, is the scandal concerning Punjab National Bank. It’s important that other banks learn that they must always follow the rules of banking — always take collateral when making a loan.

 

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