Transparency, Key to Industry’s Liquidity Crisis

The global diamond industry, poised on the brink of a golden age, faces the severe threat of a serious liquidity crunch. Even as the 80-year old Antwerp Diamond Bank, which financed nearly 1/3rd of the trade, is on the brink of being officially declared dead, the message for survival is clear – The industry needs to come together to create transparency. That’s where the future lies.

Being a capital intensive industry, financing is crucial for the various segments of the diamond value chain. The rough traders, the cutters and polishers need working capital to buy rough diamonds from the producer, typically paid for upfront, besides the investment capital for purchase of specialised machinery to manufacture the jewellery containing polished diamonds. While the producers and retailers at either end of the value chain can tap the debt and equity capital markets, polished diamond trading and cutting and polishing account for the greatest share of financing demand from banks, states Bain’s The Global Diamond Report, 2014.

Nearly 80% of the current outstanding debt of USD 16 billion is concentrated with fewer than 5% of the players. India accounts for about 40% of borrowing worldwide and receivables financing is the most common product, accounting for about 65% of outstanding debt, informs the Bain Report.

Following the economic slowdown, since 2012, the diamond banks, serving the industry for decades, faced several cases of loan defaults. The ratio of non-performing loans to total assets rose from less than 1% across the industry to the 4-10% range. But instead of taking stern action against the defaulters and getting rid of them, the banks tightened controls and the whole industry is being virtually penalised for the misdeeds of a few.

Admits Kishore Lall, Managing Director and Global Head of Diamonds & Jewellery – Standard Chartered Bank, London, “All banks do not handle that situation well. Common sense would dictate that when we have a problem with a few clients, it means we need our good clients now, even more. What happens in real life is just the reverse. You tighten your belt and you tighten the belt across all clients, in particular the good clients and the same yardstick is applied across the board. That’s a generic global banking issue. Defaults by a few players in the diamond industry created a stigma and a taint across the whole industry within the managements of those banks who financed them.

The lack of transparency and the perception of the diamond industry being open to money laundering further weakened bank confidence. Banking regulators imposed stricter requirements on banks. The Basel norms introduced leverage, liquidity coverage and net stable funding ratios, as well as tightened the rules governing concentration risk. More stringent anti-money laundering regulations were added to banks’ reporting and organisational requirements, leading to banks enduring higher costs of lending. Banks thus focussed their attention on the diamond industry and reduced their exposure to the industry.

The Bain Report states that the long term bankers ABN AMRO Bank, Standard Chartered and State Bank of India are reducing the percentage of stones financed to 70-75% from 100%, while tightening borrower solvency ratios. Israeli banks have also reduced their exposure to the overall industry and narrowed their focus to the domestic diamond market.

Credit policies became conservative and banks brought in regulatory constraints, which are here to stay and have to be accepted.

Says Erik Jens, CEO ABN AMRO Bank, “We are in this together. The formula of bankability for us is the sum of profitability and transparency, including a complete set of consolidated and audited accounts, complete identification at all levels, including ownership and compliance with business processes and evidence of best business practice principles. For good companies, there is sufficient liquidity and we will be here for the next 100 years to provide it.”

The report predicts that without changes to the industry’s ways of doing business, diamantaires face a period of deleveraging that could weed out the weakest players and also see available levels of financing fall by as much as USD 3 billion in the medium term. Credit constraints would mostly impact the small and medium enterprises.

To access the limited liquidity, the report suggests that SMEs would need to increase the transparency of middle market operations by improving reporting standards which comply with international financial reporting standards and enhance their inventory appraisal procedures to give banks more confidence in their business.

Says Kishore Lall, “When we talk of transparency, it’s not enough that you see through, but that the transactions be bonafide and be real trade transactions. Bankers are in the risk taking business and it is okay when business projections do not work out. But when clients misrepresent and we find out that in fact, the third party transactions are not genuine, that causes an enormous amount of grief.”

The Bain report informs that one major diamond jewellery player went in for extensive modernisation and implemented an end to end ERP system to support business processes and track inventories as they moved through the manufacturing pipeline. It also adopted IFRS reporting and subjected its annual reports to external audits. Such players understand that brining transparency is inevitable for increased liquidity.

The Know Your Customer (KYC) norms are also a key to bring in the transparency into the industry while helping to reduce the transaction cost. Says Pranay Narvekar, who has worked on the My KYC Network, a project undertaken by the Gem and Jewellery Export Promotion Council (GJEPC). “Today, you need to do due diligence in all your transactions and the KYC, or in reverse, the Know Your Supplier norms, which apply to all levels of the industry, from the producers to the retailers, helps you to do that. It is based on the premise that in an industry where everyone deals with everyone else, even non-cash transactions carry a potential risk. So, you need to do due diligence and know both who your customer is as well as who you are buying from and also whether his money comes from a clean source.”

Currently there is no KYC standard and every company has their own KYC, realising that the deeper it cuts through the KYC levels, the more transparent it gets.

Banks are willing to support the diamond industry. Says N.K.Chari, Deputy Managing Director, State Bank of India, “We need to respect the stricter regulations. The changes in the ECGC norms of credit insurance are a major concern for the industry. We, as bankers, support the industry and are willing to interact with the ECGC and make the data available to them to see diamonds as a segregated section of the gem and jewel industry with a positive credit track record.”

Bankers are also willing to support players who share their demand plans with strategic suppliers, giving the bank an unobstructed view of the production pipeline. This could enable the lender to develop a dedicated credit policy for the entire chain, and perhaps even override the credit rating of a supplier and upgrade it based on the stronger credit rating of the ultimate manufacturer or retailer, suggests the Bain report.

The initiative has to come from within the industry. The writing is on the wall. The days of trust and Mazal U’ Bracha, Hebrew for Good luck and Blessing, traditionally said at the time of closing a diamond deal, are gone for ever.

 

[Cover Image Courtesy: Isle of Man 2012 Diamond Jubilee of Queen Elizabeth II Coins, Pobjoy Mint Ltd.]

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