Inside the $1bn swindle shaking India's banks

India Cricket Fans

A near-$1bn money laundering scandal in New Delhi is threatening to ensnare some of the country's largest banks.

In a matter of a month, Ashok Vihar has gone from a run-of-the-mill neighborhood in India's capital city to the center of a near $1 billion money laundering scandal that is threatening to ensnare some of the country's largest banks.

Bank of Baroda, India's second-largest state-owned bank by assets, has operated a local branch in the area for decades where local shopkeepers and families kept accounts. Now, that branch is being investigated for illegal foreign exchange transactions estimated at as much as 60 billion rupees ($922 million) with the trail of evidence spanning from the Middle East to Latin America.

The Central Bureau of Investigation (CBI), India's main investigating police agency, reckons that 59 account holders at the Ashok Vihar branch and an unknown number of bank officials allegedly conspired to funnel money to 417 partners in Hong Kong and one in the United Arab Emirates under the guise of import payments for cashews, pulses and rice.

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Except the food imports didn't exist and the transfers were in violations of India's Foreign Exchange Management Act.

The scandal is a source of embarrassment for Bank of Baroda, which was founded by Maharaja Sayajirao Gaekwad III in 1908 and survived a crisis during the First World War when as many as 87 banks failed in India, and comes at an uncomfortable time for the central government that has seen some of its popularity dented by stalling of crucial reforms .

Authorities have stepped in, with junior finance minister Jayant Sinha meeting state-run bank chiefs in New Delhi on Wednesday to discuss the matter.

Private banks have been impacted as well, with HDFC Bank—India's second largest private lender—announcing the suspension of an employee in connection with the case last week.

Meanwhile, local newspaper DNA reported that a South Korean citizen residing in Mexico City may also be linked to the case.

Millions were reportedly remitted to a company called Jasco Ltd that was opened by a man named Kim Jun Hyung in 2008, DNA said. Kim transferred the company to two people in November 2014, which was a few months after the monetary transactions started taking place from India to this company, the report added.

The illegal remittances occurred between May 2014 and July 2015, during which the 59 accounts were opened, Bank of Baroda said in a statement last week. In that period, around $576 million was transferred out of India, the bank added, which is much lower than the CBI's estimated $922 million.

The majority of the funds in the 59 accounts were initially deposited via bank transfers from 51 different banks and each transaction out of India was less than $100,000, according to Bank of Baroda and the CBI.

Bank of Baroda said it first detected irregularities at the Ashok Vihar branch in July and then requested an internal investigation, which only began on September 22. Two days later, the matter was reported to the CBI as well as the central bank and the finance ministry.

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Several arrests have already been made, including the assistant general manager and a foreign exchange officer at the Ashok Vihar branch, the CBI said last week. Searches at 50 locations on various companies suspected of involvement revealed that most of the addresses given were either false or the companies did not exist at all, the CBI added.

Bank of Baroda has stated that it doesn't anticipate any significant financial losses from the case.

While Asia's third-largest economy is no stranger to financial crime, the scandal comes at a time of rising foreign investor impatience with Prime Minister Modi's much-discussed fiscal and structural reforms, including those linked to state-run banks, many of whom are hobbling due to patchy loans.

However, analysts told CNBC that they weren't too concerned about broader implications for India's banking sector or investment.

"We think multinational corporations need to monitor this since public financial institutions are under scrutiny and many of their local partners do fund expansion through state-owned banks. But as always, the real essence is in the pace and thoroughness of execution," said Pratima Singh, senior analyst at research firm Frontier Strategy Group.

This case is basically a reminder for tighter financial regulation, explained Pramod Gubbi, director of sales at Ambit Capital, an Indian financial services firm.

"At a time when New Delhi is going after black money, this will help clean up the system."

The case has already sparked calls for the Indian central bank to impose stricter rules on banks, including reporting cases involving multiple transactions from a single account within a short period.

"My utmost priority is to examine the current situation and bring about the necessary changes within the bank to ensure such unfortunate incidents do not recur. This will include the appointment of an external accounting firm for full review of our Know Your Customer (KYC) norms and its effectiveness across all branches," said Bank of Baroda CEO and managing director P.S. Jayakumar, in last week's statement.

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