This summer when I went to my home town, my dad was asking me about Punjab National Bank scam. He understands the gist of it but naïve to financial terms used by media to explain it. Here is the excerpts of our conversation:
Dad: How exactly Nirav Modi did the scam?
Me: A couple of junior level Mumbai branch officials fraudulently issued Letters of Undertakings for companies associated with Nirav Modi.
LoU is like a guarantee given by one bank to another bank to repay a loan on behalf of a client. It empowered Nirav Modi to get a loan (buyer credit) from foreign Indian bank (Allahabad Bank, Hong Kong) to import material into India. Hence, in actual, the loan was issued without any security (collateral) and was never used to import goods in India.
Dad: This seems very easy, no additional verification by a foreign bank?
Me: Bank issuing LoU needs to transmit SWIFT instructions to a foreign bank which is like an instant messaging service. SWIFT instructions are trusted by all the banks over the world. PNB employees conveyed SWIFT instructions to HongKong branches without getting proper authorization from the senior officials. Ideally this should have been detected in bank transaction records; however, PNB did not have a centralized Core Banking System. Fraudulent Mumbai branch officials kept the record hidden within the branch.
Dad: Interesting! It’s repeatable J
Me: Indeed, however, such mortgage fraud can be mitigated with Blockchain technology.
Dad: What is Blockchain?
Me: In simple terms, Blockchain means maintaining data in blocks and each block is linked up with other block within the network. Blockchain is an append-only transaction ledger (record of financial transactions) which means the digital ledger can be written onto with new information but the previous information, stored in blocks, cannot be manipulated. Blockchain uses cryptography to link the contents of a newly added block with each block before it such that any change to the contents of a previous block in the chain would invalidate the data in all blocks after it.
Dad: How it could have prevented the fraud?
Me: Blockchains are consensus-driven. All the blocks connected to the network must agree on a transaction. This could have stopped convicted PNB employees sending LoU without proper authority as there could be one block needing approval from senior official/branch manager.
This could have also stopped issuing LoU without any security.
Dad: Is that all?
Me: No papa, one of the most critical components of Blockchain is Decentralization, it distributes control among all peers in the transaction chain, creating a shared infrastructure. That is, no single entity can take control of the information on the Blockchain. Therefore, we need not trust a single entity since we rely on agreement by many entities instead. The beauty of this construct of a Distributed Ledger is that the transactions recorded in the chain can be publicly published and verified, such that anyone can view the contents of the Blockchain and verify that events that were recorded into it actually took place.
And if you are concerned of security, Blockchain enables an exchange of transactional value using unique Digital Signatures that rely on public keys (decryption code known to everyone in the network) and private key (codes known only to the owner of transaction) which means you need to hack all the public-private keys of the nodes in chain and alter them at the same time if you wish to do a fraud.
Dad (excitedly): This could have stopped issuing LoU without security or to have transactions hidden from central authority.
Me: Exactly. Most mortgage fraud is perpetrated by either the borrower or broker and is missed by lenders (banks, financial institutions, etc.) Blockchain systems flag contentious articles for review by lenders making fraud much simpler to spot.
Dad: This looks really good, is this all theory?
Me: Research is going on to have full-fledged software to support this technology. Block66 – a blockchain-based solution announced the creation of its new platform designed to increase transparency and root out mortgage fraud. There are other companies as well as harnessing the power of Blockchain technology. We should have something ready very soon!
Dad: thanks Beta
Me: (no words, just a satisfactory smile)
by Jibran Shajie