Stock markets in India are presently trading marginally higher. Sectoral indices are trading on a mixed note with stocks in the IT sector and consumer durables sector witnessing maximum buying interest. Realty stocks are trading in the red.

The BSE Sensex is trading up 73 points (up 0.2%) and the NSE Nifty is trading up 17 points (up 0.2%). The BSE Mid Cap index is trading flat, while the BSE Small Cap index is trading down by 0.1%. The rupee is trading at 64.52 to the US dollar.

In the news from the banking sector, Fitch has placed Punjab National Bank (PNB) on 'Rating Watch Negative' (RWN), reflecting a possibility of downgrade following the US$1.77 billion fraud.

Fitch said that the fraud has raised questions on both internal and external risk controls as well as the quality of management supervision considering that the fraud went undetected for several years.

The PNB fraud case involves bank employees issuing unauthorized LoUs to three companies and four people, including Nirav Modi and Mehul Choksi.

The fraud is essential that Nirav Modi did not pay the security deposit needed to raise an LoU. These LOUs were used to obtain short-term credit from overseas branches of other Indian banks.

The detailed investigation found that Nirav Modi had not been putting in enough of security deposit since 2011; the value of LoUs without these deposits is now around Rs 114 billion.

The above scam has put the public-sector banks (PSB's) in the limelight for all the wrong reasons. PNB is defrauded to the tune of US $ 1.77 billion. That's the last thing these banks needed after the crisis they've had in the past few years.

While their bad loans struggle has been going on for a decade, there are other issues that have recently cropped up adding to their pile of misery. Bureaucracy and a lack of autonomy have ensured the sub-optimal profitability and asset quality of these state-run banks.

That's the reason we've been wary of PSU banks since 2014. This was well before the market had caught a whiff of the NPA problem. We've recommended just two large PSU banks in StockSelect since then...and already successfully closed both of them.

In other news, as per an article in the Economic Times, the Income Tax (IT) Department has attached seven properties of the Gitanjali Group and its promoter Mehul Choksi in Mumbai in connection with a tax evasion probe against them.

The department has issued an order for provisional attachment of flats and buildings of these entities, which are located in the Opera House, Bandra, Andheri, Wadala and Walkeshwar Road areas of the Maharashtra capital, under the provisions of the Income Tax Act, 1961.

Note that the stock of Gitanjali Gems has nosedived on several occasions since 2013, eroding market capitalization by over 80%. Its promoter's role in aiding Nirav Modi carry out one of the biggest frauds in the banking history has damaged the stock's position and credibility. Reportedly, Gitanjali Gems and its two subsidiaries fraudulently acquired letters of undertaking and letters of credit worth Rs 48.9 billion issued through Punjab National Bank.

Gitanjali Gems, the Fall Guy

It has emerged that Gitanjali Gems' receivables position has been outstanding far longer than that allowed by the RBI. Auditors have pointed out the overdue loans/debentures and overdrawn working capital limits by the company in the latest annual report. In fact, the company has said that it does not even have funds to honor debenture redemption liability of as low as Rs 14.8 m.

We had stuck our necks out, warning investors that Gitanjali Gems' shiny exterior is a sham. Being in a working capital business of importing gold and exporting jewelry, regulatory restrictions on gold imports in FY13 pushed the company into deeper debt. But the company's weak management, integrity, and ethics were completely unacceptable to us. Therefore, despite Gitanjali Gems attracting institutional interest during the gold rally, we had clearly asked investors to steer clear of this value-trap.

Connecting the dots in the aftermath of the fraud undoubtedly confirms that the dubious management is responsible for the company's downfall, something we had seen coming long back. Clearly, management integrity is one aspect that shareholders cannot afford to compromise in their frenzy to ride the bull run.