The PNB scam and the price action it brought with it

PNB has found itself at the centre of the biggest banking fraud in the history of India. The second largest public lender struggling with high NPA’s and bankruptcy resolution cases is now in the middle of 11,400 Crores.

Mr. Nirav Modi, the man in the middle of the controversy, seems to be the front-runner in the race to be the next Mallya. A luxury diamond jewellery designer who was ranked #57 in the Forbes list of India's billionaires in 2017. He is the head of a chain of diamond retail stores with Firestar International as the the parents company of the group.

How Nirav Modi along with 2 employees conned the second biggest lender of the country?

Nirav Modi approached PNB for Letters of Credit to purchase precious stones from foreign exporters. This implies that PNB pays on behalf of Nirav Modi’s brands which would be re-payed in a pre determined time frame.

Since Nirav Modi could not provide enough collateral, he colluded along with senior PNB employees to generate fake Letters of Undertaking (LoU) which helped him gain extra credit and fund overseas buying of precious stones.

How the fire spread ?

PNB presented these fake LoUs to foreign branches of other Indian banks such as Axis Bank and Allahabad Bank to get loans to pay off these transactions. Thereby passing on the risk and reducing their exposure. These banks transferred the funds to PNB’s nostro accounts. A nostro account is a account which a bank holds in a foreign currency in another bank.

How did the management and auditors not see this?

The two employees of the state owned lender directly used SWIFT: the global financial messaging service used to move millions of dollars across borders every hour and bypassed the Core Banking System (CBS) which processes daily banking transaction and post updates. It was a ploy to avoid immediate detection: the SWIFT messages used to raise overseas credit were not readily available in PNB’s FINACLE software system as these were issued without entering into the bank’s CBS.

So that was a little brief on what actually happened.

It is said that price incorporates everything.

Then let’s have a look at how PNB’s stock price movement reflected this news. This is PNB’s daily frequency chart:

The official announcement of the scam was made on 14th Feb, 2018 and the stock opened with a gap down that day and the price plunged 28% to form a new 3-month low. PNB was the most actively traded stock on 15th Feb and it’s volume reached all time highs.

Also, one more noticeable thing here is, although the news had been released on 14th Feb, the stock was on a downtrend since 25th Jan.

PNB’s stock had been going strong owing to the PSU bank’s or rather the whole market’s pre budget bull run. On 24th Jan, the price hit a 3 month high as well as opened with a gap up on 25th Jan but tanked since.The massive fall on 25th was on account of the fact that big state lenders were expected to receive less funds through the recapitalisation plan initially announced on 23rd October (That day, PNB’s stock was up 45%). This news acted as a trigger to end the bull run as well as gave way to a new bear trend which was partially because of rumors of the scam coming into public domain.

This news also reflects in the chart in form of certain patterns, the three candles marked in the chart form something called a tweezer top and another pattern known as three blacks crows, which are both bearish reversal patterns. A study of some more technical indicators also clearly indicates that PNB was a stock that had a reached it’s peak.

This is the data of the Feb expiry futures of PNB. It can be observed that on the days when these news came, the fall in PNB’s stock price was accompanied by a massive increase in open interest. This is called a short build up which is also an indicator of a new downtrend starting.

This is how the price action and charting patterns incorporated the news in them. Not just PNB, the other banks that suffered due to this scam also witnessed plunging of their stock prices.

Well if I was Nirav Modi, I’d have certainly paid back my defaulting loans by buying PNB put options.