In Mumbai diamond circles there is much talk about a candid “name and shame” letter in which a major diamond industry financing institution identifies a number of clients (some of them DTC Sightholders) who are defying their borrowing covenant with the bank, defaulting on their obligations and skirting the laws of the land. The letter notes that “in the face of continuing default, we would have no option but to blacklist the firms, companies, their associates and buyers, with DTC, Dun & Bradstreet and with world-wide [diamond] bourses.”

Very few people have actually seen the letter, but its impact and ramifications have not been lost on any member of the Indian diamond industry. The bank goes out of its way to note the “high level of integrity of the diamond manufacturers” and their “exemplary track record established over decades,” which “is on the verge of being breached by the actions of a few promoters.”

We used a short stay in Mumbai to find out what practice had invoked the ire of the bank. The seven companies mentioned in the letter have made polished exports to associated companies, relatives and oversea third parties and have enjoyed the financing of the bank. At some point, remittances almost totally stopped coming in. According to the letter, “Non-receipt of a single bill for 3-6 months at a stretch, as is happening in a few cases, is inexplicable.”

What apparently really angers the bank is that some of the clients involved, who enjoy an extensive credit line with the bank, are clearly behaving in bad faith. Repeated phone calls, for example, are not returned. In some instances there seems to be a complete breakdown of communications. If the non-receipt of any remittances over an extensive period happens in “good faith,” the diamantaire would be talking to his bank. These “shamed seven” aren’t talking– at least not until the letter was sent. The bank, which officially cannot comment on the letter, is really trying to work it out with its clients.

It is hard to fully understand what is happening. In one instance, which we were able to verify, a particular diamantaire fears that if export proceeds are credited to his account, the bank may reduce his lending facility by the very same amount. These fears may not be exaggerated; we know of a bank in Israel that did just that. This fear has apparently led some banking clients to shift the transfer of remittances for exports financed by one bank to another, sometimes even in another country. Thus the diamantaires had the use of the funds, while the bank was kept waiting.

Based on the best of my information, most of the companies involved are not in serious financial straights – though two of the listed firms may be close to facing bankruptcy. Undoubtedly, some on the list will face insolvency if their credit facilities are significantly reduced. There is no intention, prima facie, not to remit the funds at some point to the bank. But at this point, these companies are clearly defaulting on their commitments and obligations. Moreover, to use the words used in the letter, these companies “are flouting Reserve Bank of India (RBI)” regulations.

Infringing Central Bank Rules

Most diamond financing institutions are government-owned, but the same rules apply to private and government banks. Playing around with the rules will, in first instance, bring in the RBI. But thereafter, especially when dealing with government-owned banks, don’t be surprised if tax officials, custom authorities, VAT regulators and others will come down on you – even on totally unrelated matters. In India, if you want to conduct your business undisturbed, don’t mess around with banks and, especially, not with a government-owned bank or with government in general. You cannot win.

Bankers know that and want to protect their customers. They will go the extra mile not to report defaults if they can still solve the problem amicably.

How serious are the legal infringements of the seven clients? It is customary practice in the Indian banking sector that, prior to discounting (i.e. financing) an export bill, banks require the exporter to draw a Bill of Exchange (“BoE”) on the concerned importer, i.e. buyer. The exporter's BoE calls on the overseas buyer to pay a designated sum of money at a certain date. Acceptance consists of an acknowledgement to written across the face of the BoE and signed by the drawee, i.e. importer. This thereby creates the effect of obligating the importer to provide the payment of the amount stated within the time period designated. I was told that most export shipments today are “open” and don’t involve banks at all.

According to the financing rules for diamond exports from India, on the invoice, in the space for “consignee,” generally the name of the overseas buyer’s bank appears, with the buyer's name in the designated space. This is done so the buyer can sign acceptance of the BoE at his bank, before it hands him the parcel. The foreign bank will confirm the acceptance of the draft to the Indian exporter’s bank.

Legal advice we obtained says that “before discounting/purchasing a bill, banks must demand a valid BoE from the exporter where the assent of the drawee is mandatory for constituting a valid BoE. We assume that before discounting/purchasing a bill, a bank will ensure that the overseas importer has given his assent and take custody of such BoE.”

If the overseas party has given its consent to make the remittance to a specific Indian bank, then the bank will also have a case to take action against the clients of the seven exporters – something which is clearly hinted at in the letter which has been circulating in Mumbai.

Blacklisting Can Become a Major Commercial Headache

When delving into this story, we found out that the diversion of remittances, essentially changing the payment instructions given to foreign buyers, is now taking place in several places around the world. The higher interest payments on deposits placed with UAE banks has also given rise to arbitrage – there is more than one reason for delaying the receipt of export remittances.

Nevertheless, missing the remittance deadlines can lead to blacklisting. What does that mean? According to Regulation 9(1) of the Foreign Exchange Management (Export of Goods and Services) Regulations, 2000 (“Export Regulations”), an exporter is required to realize and repatriate the full export value of the goods exported within six months from the date of export. A financing bank, by law, is obligated to report the non-receipt of remittances – and also to report the names of the overseas clients who failed to make the payments – or who have made the payments to a different bank, at the request of the exporter.

We checked, and the relevant Export Circular provides that Authorized Dealer banks should furnish to the concerned regional office of the RBI, on half-yearly basis, a consolidated statement giving details of all export bills outstanding beyond six months from the date of export at the end of March and September every year. The statement should be submitted in triplicate within fifteen days from the close of the relative half year. Inter alia, the statement also requires disclosure as to the name and address of the overseas importer (i.e. the buyer) in relation to the outstanding invoices.

The term “Black List” is slightly misleading. It refers to an “Exporter’s Caution List,” which is maintained by the RBI and on which the central bank places the names of those exporters who have come to its adverse notice in regard to realization of export proceeds. Once an exporter’s name is entered onto the Exporter’s Caution List, such exporter is required, before making subsequent exports, to submit the export-related documentation through an authorized dealer to the RBI for its prior approval. The submitted documentation also needs to be supported by documentary evidence to show that such exporter has received advance payment or an irrevocable letter of credit in his favor covering the full value of goods to be exported.

Basically, a requirement to get advance payments or a letter of credit on any diamond shipment from India is something not a single Indian diamond exporter is able to do. A diamantaire on the so-called “Black List,” at least in theory, can forget about his business.

There is another aspect here. India still has very stringent foreign currency controls, which are contained in the FEMA legislation. Not bringing in export proceeds is seen as a flight of foreign currency from the country. It is far more serious than just defaulting on an obligation to a bank. One industry leader told me that, in the past, even in some instances where he could show that his U.S. client had filed for Chapter 11 and he didn’t get his money, he somehow arranged for the open bill to be paid out of his own resources – simply to avoid problems with the authorities.

This underscores the seriousness of the issue.

Implications for the Industry at Large

The troubles created by a handful of players adversely impact the exemplary record of the industry. “This [behavior] constrains us in our efforts to extend the much needed support to the industry at this critical juncture,” warns the bank’s letter.

We have argued with ourselves whether we should publish the seven names or the name of the bank. After all, what is the use of “naming and shaming” if not all members of the industry are made aware of it. We decided not to publish the names for the time being. We believe that the purpose of circulating the letter is to give a general message: don’t risk the relationship with your bank – if you have a problem, come and talk to us and we’ll solve it together. Playing games will only bring unintended consequences and start a domino effect with the RBI and government that one may not be able to roll back or contain.

Surely, this concerns us all. Nobody wants to give credit to a trade partner who may be embroiled in serious conflicts with his bank – and possibly also in violation of industry best practices, which may lead to sanctions by rough and other suppliers as well.

Our advice to the seven companies: talk to your bank. There is too much at stake.

Have a nice weekend.