Re-evaluating DiamonD Financing Risks

There’s a shift in the stance of diamond financing banks, who are growing more cautious by the day. Having recently burned their fingers with two major defaults, the purse strings are beginning to tighten. The squeeze on credit is already being

felt by the industry. But banks are optimistic about the industry’s future and feel that there is potential for growth. In an exclusive interview with SOLITAIRE,

MAULIK SHAH, the co-founder and CEO of Almus Risk Consulting and a member of the GJEPC’s advisory panel for banking and treasury, outlines the best

practices for maintaining the trust between the industry and banks.

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Tell us a bit about yourself and how long you have been associated with the diamond industry.I’m a chartered and cost accountant by qualification. In 2002, I joined Rosy Blue India, the world’s leading diamond company. I was chief financial officer of the company and served for 10 years. In 2012, I moved out and set up Almus Risk Consulting along with a co-founder. Currently, I’m the CEO of Almus, and also an advisor to the GJEPC on banking and treasury issues.

Can you give us a break-up of the various top banks’ exposure to the Indian diamond industry?The numbers are not publicly available. But here’s a guesstimate.SBI: I4,000-I5,000 croreRBS: I4,000 croreIndusInd: I2,000-I2,500 croreBOI: I2,000 croreSCB: I1,500 croreOther PSU Banks (BOB, Corporation, P&S, PNB, Dena, Canara, IOB, SBT, UBI): I500-I1,000 crore eachOther Private Sector Banks (Yes Bank, HDFC, Kotak): I500-I1,000 crore

According to the Reserve Bank of India, banks had an exposure of J71,500 crore ($11bn) to the gems and jewellery sector at the end of April 2015. With tightening of lending norms, is this figure likely to drop and by how much over the next 1-2 years? What percentage of this could turn into non-performing assets (NPAs)? Since my experience is more from the diamond industry, let me focus on diamond lending. My estimate on lending to the diamond industry alone is between I30,000 crore and I35,000 crore. The figure is likely to drop due to a slowdown and aversion of banks to lend to the industry. Ideally, with the increase in awareness about risk management by companies, and a prudent approach by bankers, NPA should come down over the next few years.

Are the major defaults in the diamond sector or jewellery sector? Please elaborate on the reasons.This has always been a point of debate within the gem and jewellery industry. There are a few major defaults that have happened in the last 3-4 years. One positive side of the default is that the core business has not incurred losses. The losses are due to forays into non-core operations. Many of these companies didn’t have professional expertise or a risk management policy.

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What is the average interest rate on diamond loans?The Foreign Currency Loans are calculated as LIBOR + 250bps to 500bps for Pre Shipment Credit in Foreign Currency (PCFC) / Post Shipment Credit in Foreign Currency (PSFC).

Indian Currency Loans are determined at 10.75 to 12.5% for PC / PSC loans.

The gross NPA of public sector banks in the diamond and jewellery sector has shot up from 5.3% in 2012-13 to 14.1% in 2013-14. Is this a good time for banks to be in the diamond and jewellery business?This sector is high working-capital-intensive due to high value goods and long working capital cycles. The sector always relies upon banks for meeting their financing requirements. For banks, the sector has been beneficial with low NPAs, regular interest earnings, foreign exchange flows (both imports and exports), treasury operations, etc.

Globally, the industry is going through a slowdown; it is part of a long-term cycle. It’s not a great idea to exit during the slowdown. Even in such a scenario, banks can lend for need-based requirements of the industry, keeping proper risk management in place. There are opportunities for banks to choose companies from the Micro Small and Medium Enterprises (MSME) segment, which incidentally spreads risk for banks.

Major defaulters like Winsome Diamonds and Forever Precious Jewellery & Diamonds have cost the banks J6,000 crore. Is there any hope of recovering this money? How do banks generally recover bad loans? I am not competent to comment on the same. However, from experience, it’s observed that banks find it difficult to recover loans. There are two major assets that diamond companies hold i.e. stock and receivables. In addition, diamond companies offer collateral between 15% and 100% of the loan amount.

Stocks and receivables are not reliable during bad times, and banks encounter legal hurdles when encashing the collateral. Therefore, there is a serious issue of recovering bad loans.

Recovery from the primary security (stock and receivables) can be improved by banks exercising proper checks on the movement of goods and KYC (Know Your Customer

Maulik Shah is the co-founder and CEO of Almus Risk Consulting, which is in the business of treasury outsourcing and currency risk management. Before setting up Almus, Shah was the CFO of one of the leading diamond companies, Rosy Blue India.

Shah is a chartered and cost accountant by qualification. He is on the advisory panel of the GJEPC for banking and treasury. He has been a speaker on banking and forex risk management in various forums, namely, Eurofinance, FICCI, IForex, and CA Study circle.

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and also Know Your Customer’s Customer). Banks can even send teams for inspections and audits at regular intervals.

Collateral recovery is an issue across the banking industry. The RBI and the government are working on the same.

In general, how will the tightening of loans impact the Indian and global diamond industry?As stated earlier, diamond industry is high working-capital-intensive and relies on availability of finance to manage the cycle. Tightening of loans will have an impact both on the Indian and global diamond industry.

There is also a positive side to the loan restriction. In the industry, mining companies have a cash model (i.e. advance payment against sale of rough diamonds). On the other extreme, retailers also operate on a cash model (from end consumers). The manufacturer, intermediaries, distributors end up investing into a pipeline stock. Tightening of loans may help improve the entire pipeline efficiency.

Over the years in this industry, have you seen the midstream changing its ways to bring in more transparency?Yes. There are both external and internal factors that have contributed to improved transparency and governance in the industry. External factors include introduction of various acts, regulations like the Prevention of Money Laundering Act and the Kimberley Process. Internal factors include audits conducted by mining companies, Best Practice Principles, RJC, governance conditions laid down by mining companies like unqualified audit reports. In addition, diamond companies have realised the importance of implementing systems and processes to be more competitive and several initiatives are being taken up by these companies, which has brought in transparency and governance.

Could you elaborate on the best practices followed by the top players that can be emulated by the industry?• Creating an organisation structure with

roles and responsibility at various levels• Induction of professionals in various

positions• Complete trail of goods flow from

rough procurement, assortment, manufacturing, polished assortment, final despatch to the end consumer

• Implementation of Enterprise Resource Planning (ERP)

• Managing interest rate risk, exchange rate risk, credit risk, liquidity risk and prudent management of stocks

• Disclosure of information in various submissions

How are the diamond industry loans structured through the banking consortia in India? The arrangement of working capital loans extended by banks is either in the form of multiple banking or consortium banking. Generally, smaller bank limits are with multiple banks and with the increase in the limit and scale of operations companies prefer the consortium route. This is highly company specific.

Will tightening of banking regulations and the increasing lending costs squeeze out SMEs from the Indian diamond industry? Does that make consolidation in the midstream inevitable?I am not sure whether tightening banking regulations and increased cost will squeeze out SMEs. In fact, today the biggest issue for the industry is that bank finance is centralised with medium to big sized players. Even banks prefer dealing with a few large accounts with high exposure. It’s a crowded place. There are real opportunities even for banks to spread out both for risk management and it’s lucrative. The SMEs of today are big players of tomorrow. Partnering with them at an early stage can be an excellent opportunity for banks.

Coming back to the question of impact on SMEs, they have limited access to bank finance. Market credits incur high costs. So, I don’t think it may have a significant impact. At the same time, consolidation is inevitable because of the prolonged slowdown and severe competition. It’s going to be “survival of the fittest”. The companies that invest in bringing efficiencies into the supply chain and finance, and look to lowering the turnaround time will survive.

What specific measures can banks take to reduce risk?• Invest in risk management• Study in detail monthly data submitted by

companies (it can give early warnings)• Continuity of key banking officials who

acquire diamond banking knowledge• Being vigilant about the entire

movement of goods• Be present in overseas market and

access information that pertains to credit risk or any other risk to the industry

• Be aware about company’s focus in core and non-core areas; whether the

In fact, today the biggest issue for the industry is that bank finance is centralised with medium to big sized players. Even banks prefer dealing with a few large accounts with high exposure. It’s a crowded place.”

company is taking excessive leverage and diversifying in other areas

• Regular sharing of information, dispute cases with the GJEPC

From a banking perspective, how do you see the Indian industry evolving over the next 5-10 years?At present, the Indian diamond banking space includes all Public Sector Banks, Private Sector Banks and Foreign Banks. This is unlike overseas markets where only a few selected banks have exposure to the diamond industry. Moving forward, we may see consolidation even in Indian diamond banking. The sector requires specialised expertise and experience. Banks that have a focussed approach, complete visibility across the pipeline, and a prudent risk management structure, will find it rewarding to continue to operate in this sector.

Apart from this, there are new opportunities for the Indian banking industry. India has its own uniqueness as a market … the only country that has a strong manufacturing and consumer base. The government of India has included gems and jewellery in “Make in India” (and now “Make for India”!!!). The government has announced a few measures like the Special Economic Zones (SEZ) to make India a global hub for the industry. A lot is still to be done on that front in the areas of taxation, legal structure, business-friendly measures, and labour laws. But, with all that in place, yes, we are looking at the Indian diamond industry to play a key role in the global diamond industry. This provides opportunity for banks operating in India.

How can the upstream (read miners) and downstream (read retailers) support manufacturers to reduce their financial burden?This connects with my earlier submission on who funds the entire pipeline. Traditionally, a miner being a monopoly player with control over supply, demands advance money and on the other extreme, a retailer with control over market is always demanding. Manufacturers are squeezed from both the ends. It’s time for every entity in the entire pipeline to be responsible for another player in the chain. Every single player in the pipeline has a role to play. One exists because of the other. It requires a paradigm shift in the way one player relates to the other. It’s not “either or” but it’s “you and me”… One has to realise that “Only when I make my fellow partner (read manufacturer) strong, will I survive”.

Do banks engage with industry bodies like the GJEPC on a regular basis when it comes to risk management?The practice was not so prevalent in the past but of late, the engagement has increased. Now they are open. The GJEPC on its part has taken a number of initiatives like organising Annual Banking Summit, World Diamond Conference, Project MY KYCBank, interaction with key bankers with the industry ...

This relationship needs to be further strengthened for better risk management. Sharing of information by banks at initial stages of dispute can definitely go a long way apart from regular interaction between all interested parties. The GJEPC has

proposed the formation of a working group structure that consists of council members and key bankers to improve the interaction.

Anything else you would like to add.The Almus team has unique and rich experience of over two decades of the diamond industry, banking and managing forex risk. It’s been our endeavour to closely work with members and the Council in the areas of banking and risk management. We had conducted a presentation in association with Diamond Exporter’s Association Limited (DEAL) and the Bharat Diamond Bourse in the past and will continue to take such initiatives by organising educative seminars for all the members. n

Sharing of information by banks at initial stages of dispute can definitely go a long way apart from regular interaction between all interested parties. The GJEPC has proposed the formation of a working group structure that consists of council members and key bankers to improve the interaction. ”

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