PNB fraud: More heads to roll in the jewellery sector

Three-four big gem and jewellery firms are showing financial weaknesses and might find it tough to withstand shocks

The fraud at Punjab National Bank (PNB) is creating ripple effects in the gems and jewellery sector, and could lead to tighter regulations.

Sources said the rising stress in the industry would mean a few more casualties in the next few quarters.

Three-four big gem and jewellery firms are showing financial weaknesses and might find it tough to withstand shocks, according to industry sources.

Jewellery companies are worried that banks will look closely at new and old loans and remove inefficiencies.

Nirav Modi and his maternal uncle Mehul Choksi had, as part of routine business practices, borrowed funds from private lenders and even purchased jewellery on credit.

Industry insiders say such loans would be worth a few hundred million dollars, if not more, and that will affect the trade money circulation cycle and normal business activities as they are unlikely to be repaid.

“Its impact will be felt for the next few months,” said a source.

Meanwhile, risk experts see tighter regulations in banks and the jewellery sector on trade-based finance.

Anurag Jain, who leads market development in Thomson Reuters Risk Business in India, said: “I expect regulatory bodies to bring in regulations around money laundering, specifically around trade finance (trade based money laundering) and law enforcement agencies to strictly enforce the Prevention of Money Laundering Act (PMLA Act).”

He said Indian companies would have to comply with global risk standards with increased focus on the PMLA Act.

Further, financial services should adopt stricter standards on monitoring foreign remittances and trade finance transactions.

The gem and jewellery trade is among the top five industries from the risk and money-laundering perspective.

Some banks including a leading foreign bank have started asking their borrowers, especially from the diamond and jewellery sector, whether they have any business relations with companies related to Modi or Choksi.

A jewellery exporter to the US said his firm had to provide KYC (know your customer) under the Dodd-Frank Act to continue exports to the US.

He is not the only one doing this. After the Rs 11,400-crore fraud in PNB, jewellers fear lenders will seek higher collateral and most firms who take the debt route to grow are exhausted in terms of providing security.

A recurring problem

An industry veteran said: “The PNB fraud at should be investigated because half the diamond industry is finding it difficult to get bank funding because of the scattered cases of fraud in the past.

"The diamond industry should not be made to suffer for the bank’s laxity of not checking their systems.”

Industry observers say every three years, this industry faces a fresh bout of problems or a crisis in which one or two such Modis or Choksis have resorted to fraud and some are caught.

Some may be lucky to stay afloat till the cycle turns but at least three-four big jewellery players are expected to fail before things settle down.

Besides, there are overseas buyers going bankrupt every year, and this ends up in Indian traders booking losses.

While this figure at an industry level is expected to be 1-2 per cent of exports, it becomes significant, considering that the value addition of Indian diamond exporters is small.

An industry veteran recalls, “In 2013, the government put several restrictions on industry and gold metal loans were converted into rupee loans.

"Apart from that companies may be receiving revenues in dollars but their working capital eligibility was converted into rupee loans.”

Since the rupee sharply depreciated soon after, many companies found their working capital or financing eligibility reduced significantly in dollar terms.

The Gem & Jewellery Export Promotion Council (GJEPC) has condemned the Nirav Modi/Gitanjali Gems incident.

The council’s spokesperson said that, “At GJEPC we are ready to assist all investigating agencies and punish the guilty.”

However, GJEPC believes that this incident will not have any contagion effect on gems and jewellery export industry.

Another industry veteran said that, “60 per cent of banking exposure is to top 100 leading gem and jewellery exporters while half of them are under stress.

"Some have survived with round tripping tactics which can’t continue more and may face survival test.”

Even GJEPC admitted that it was struggling to garner financing for exporters, especially the small and medium ones, who are required to give higher collateral for the limit sanctioned to them “and in this case one finds this kind of clear advances (LoU) being provided by a bank without any safeguards, that speaks volumes of irregularities that needs to be thoroughly investigated.”

Photograph: Denis Balibouse/Reuters