Genesis of scams in Financial Services sector – Manner and causation

Life is a full circle. This adage plays out consistently in the financial services market. Scams in the financial services market do make a comeback every few years. I was recently discussing this aspect in a meeting of a closed group comprising Board of Directors and Senior Management team of Maanaveeya Finance (https://www.maanaveeya.org). Nominees of Oiko Credit Global (https://www.oikocredit.org) were also present during this interaction.

The specific lens that was used were – Scams in India like:

A.    IL&FS (https://www.ilfsindia.com/media.aspx): The IL&FS scam involved massive financial mismanagement, hidden liabilities, and fraudulent accounting within the IL&FS group. The company borrowed extensively, routed funds across subsidiaries, and concealed defaults, creating an unsustainable debt spiral. Its collapse in 2018 triggered a systemic crisis, exposing governance failures, oversight lapses, and deep structural weaknesses in India’s financial sector.

B.    HDIL (https://hdil.in/investor-relations/cirp/): The HDIL scam centred on Housing Development & Infrastructure Ltd colluding with PMC Bank officials to hide massive loan defaults. HDIL received disproportionate, unsecured lending, while bank records were falsified to mask non-performing assets. The fraud collapsed PMC Bank in 2019, exposing severe governance failures, regulatory blind spots, and borrower–lender collusion; and

C.     SREI (https://www.srei.com/completion-cirp-process-sifl): The SREI scam involved large-scale irregular lending, evergreening of bad loans, and diversion of funds by SREI Infrastructure Finance and SREI Equipment Finance. Inflated asset values, related-party transactions, and falsified financials hid mounting losses. Its collapse in 2021 led to insolvency proceedings, revealing governance failures, weak risk controls, and extensive misreporting.

Using these, as a case study, deliberations on causation, manner, culpability and responses of the stakeholders involved was done.

As a key facilitator of these discussions, I took the liberty of summarizing the manner of perpetuating the scams in the following three heads:

1.     Using of Estimates:

Illustratively tabulation of ILFS use of accounting estimates to perpetuate fraud:

Area	Nature of Estimate Abuse	Effect
Project revenues	Inflated traffic/revenue assumptions	Showed SPVs profitable
Project costs	Suppressed cost overruns	Delayed loss recognition
Loan loss provisioning	Low PD/LGD, inflated collateral values	Bad loans hidden
Investment valuations	Overstated subsidiary values	Avoided write-downs
Cash flow projections	Unrealistic future recovery	Misleading going-concern
Inter-company funding	Fabricated repayment capacity	Masked defaults
Arbitration receivables	Optimistic outcomes assumed	Inflated assets

Its important to note that these are technical in nature and are subjective assessments. Thus independent directors / nominee directors should get involved in trying to arbitrate if there is difference in assessment between various involved parties (Auditors, Management, Key personnel). It is best that independent directors get opinions from formal bodies (like Accounting Advisory Board of The Institute of Shartered Accountants of India) and instruct the management to adopt the opinion as received.

2.     Fictional set of transactions

The HDIL–PMC Bank fraud involved large-scale fictitious transactions, primarily to hide ballooning exposure to HDIL and keep PMC Bank appearing compliant with RBI norms. Here is how these fictional transactions worked:

a)     Creation of 21,000+ Fake Loan Accounts

PMC Bank officials:

·       Created thousands of non-existent borrower accounts.

·       These accounts were used to:

o   Break up the large HDIL exposure into small entries.

o   Avoid classification of the main HDIL loan as NPA.

o   Show diversified lending when, in reality, 73% of the loan book was to HDIL.

These were pure fictitious book entries, not real customers.

b)     Dummy Entries to “Regularise” HDIL’s Overdue Loans

When HDIL defaulted:

·       Bank managers passed circular / dummy credit entries.

·       Artificially credited interest into HDIL’s account.

·       Showed loans as “standard” despite continuous non-payment.

This kept HDIL’s loans out of NPA category.

c)     False Overdrafts & Evergreening

Officials extended:

·       Fake overdraft limits.

·       New loans to shell accounts whose proceeds were immediately credited back to HDIL.

This circular funding made HDIL loans appear serviced.

d)     Masking True Exposure Using Parallel Core Banking System (CBS)

PMC staff maintained:

·       A parallel database (dummy CBS) where HDIL bad loans were hidden.

·       Actual CBS was manipulated to show only a fraction of real exposure.

This is the core of the fraud.

e)     Fake Valuations and Security Cover

HDIL submitted:

·       Inflated property valuations.

·       Undocumented collateral.

·       Bank accepted these at face value without verification.

This supported the fictitious loan structures.

3.     Related Party transactions

a)     Routing Loans via Public Trusts and Related Entities

·       According to The Economic Times, SREI lenders (Srei Infra and Srei Equipment) allegedly routed large amounts of lending through public trusts in which the SREI group had economic interest.

·       These trusts might have been used to mask connected-party transactions, making them less transparent and more difficult for outsiders (or even some lenders) to trace.

b)     High-Value Fraudulent Disbursements to Promoter-linked/Related Firms

·       The transaction auditor (BDO India) flagged ₹13,110 crore of allegedly fraudulent transactions in Srei Equipment Finance (SEFL), under Section 66 of the IBC. 

·       Within these, ₹1,283 crore were specifically “undervalued” — meaning the price or terms of the transactions were not at fair market value, suggesting preferential treatment.

·       The SEFL administrator filed an IBC application (Section 60(5) and 66) against Aviral Maritime Infrastructure Dahej Pvt Ltd and Adinath Port & Logistics Pvt Ltd, both of which are linked to the Kanoria promoters.

·       Another IBC application names Maa Santoshi Enclave Pvt Ltd and Kraft Alloys Pvt Ltd along with the Kanoria brothers.

c)     Specific Large Loans to Related / Promoter-connected Companies

·       Forensic auditor BDO (or another professional agency) found at least five loan transactions worth ~₹1,492 crore to companies such as Aviral Maritime, Adinath Ports, Kitply Industries, Swachh Group, Whitefield Paper Mills, and Bengal Industrial Infrastructure.

·       The largest among these was ~₹838 crore to Aviral Maritime & Adinath Port. 

·       The report explicitly names Hemant Kanoria and Sunil Kanoria (promoters) for their involvement in these loans.

d)     Trusts & Shell Entities for Fund Diversion / Siphoning

·       According to Moneylife, a much-criticized investigative site, SREI allegedly used a trust called “Power Trust”(controlled by people close to the Kanoria family) as a conduit to route related-party transactions or siphoned funds.

·       The same report alleges that many SREI-group companies (or promoter-linked businesses) were shell or low-substance entities. Named entities include: Bhaskar Silicon Pvt Ltd, Environ Energy Corporation Ltd, Swaymbhu Natural Resources Pvt. Ltd., Vara Technology Pvt. Ltd., Attivo Economic Zones Pvt. Ltd., I-Log Ports Pvt. Ltd., etc. 

·       These entities allegedly received loans or funding from SREI or related group firms, which may have been used to funnel money in a way that appeared legitimate in the books but was essentially “inside” the promoter group.

e)     Promoter-Level Allegations and Denials

·       The promoters (Kanoria brothers) strongly deny the fraud linked to related-party deals. Hemant Kanoria has claimed that all audited transactions were given a “clean chit” by statutory auditors previously. 

·       He further alleges that the transaction auditor’s investigation (BDO) was done in a “opaque manner”, without proper engagement or inputs from the promoter side.

Whilst the manner is easy to examine post facto, I always feel that the causation leading to perpetuating these scams was more important. If these causation factors are understood, the ability of discerning directors to intervene and prevent scams would be substantially better. This leads me to posit that there are two main causes of scams taking place:

1.     Flawed business model:

A comparative tabulation of the business model flaws is presented below:

Company	Business Model Inherently Flawed?	Why
IL&FS	Yes – structurally fragile	High leverage, ALM mismatch, long-gestation infra assets
HDIL	Yes – highly volatile & speculative	SRA dependence, political risk, land banking
SREI	Partially flawed	High-risk borrower mix + weak governance rather than concept flaw

In a world more focused on effectiveness, the Board members of each of these companies should have put in substantive check to ensure that these business model flaws don’t manifest as scam (which did happen). IL&FS board could sure have addressed its Long gestations assets with funding lines from entities which have a long term view.

2.     Flawed Governance design:

A tabulation of issues with governance design as a contrast between the three entities.

Governance dimension	IL&FS (in practice)	HDIL (in practice)	SREI (in practice)
Scale & complexity of corporate structure	Massive SPV network (>300 entities) — opacity helped hide inter-company flows.	Typical real-estate holding / subsidiary structure; less SPV-dense but used shell entities for transactions.	Multiple lending entities & international affiliates; complex but more focussed (equipment finance). Auditor/administrator flagged internal transaction issues.
Use of accounting judgements / estimates	Aggressive non-recognition of impairments; optimistic recoverability assumptions. Recast financials required.	Not primarily estimate-based — alleged falsification and fabrication of bank entries to hide loans.	Some entries identified as fraudulent by administrator/auditor (not just optimistic estimates).
Related-party / intra-group exposure	High; many inter-company loans and circular funding. Weak disclosure.	Evidence suggests use of related / linked firms to route funds; shell routing alleged.	Related-party and large transactions flagged; controls appeared weak.
Regulatory / auditor failure	Auditors and boards missed or did not act on warning signals; SFIO/forensic reports later found problems.	Bank internal controls (PMC Bank) and regulator oversight failures allowed concealment for years.	Auditors/administrators eventually uncovered fraud; earlier oversight failed to prevent issues.
Evidence of intentional fabrication	Forensic reports allege misstatements and deliberate concealment across entities (SFIO/CBI investigations).	Strong: thousands of fictitious accounts / falsified records alleged in PMC Bank-HDIL case.	Auditor/administrator reported specific fraudulent transactions (thousands of crores flagged).
Promoter / top management implicated	Multiple senior managers named/arrested in probes; governance at top widely criticised.	Promoters (Wadhawans) arrested / charged in money-laundering and bank-fraud cases; multiple chargesheets.	Management under scrutiny; administrators and auditors have reported fraud on their watch; legal processes ongoing.
Root cause (summary)	Leverage + maturity mismatch + opaque SPV network + weak oversight.	Over-leverage + deliberate concealment / manipulation of bank books to keep funding flowing.	Funding stress + weak controls + alleged fraudulent transactions / misclassification.

In this days of AI, I am sure we could create technology check points based on understanding the causation. A call out to all my clients in technology space to come up with a solution. I am attaching a copy of my presentation slides too. All those interested i am happy to chat and engage in progression.

MF 2025 on nbfc.pdf

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