Diamonds would rob banks of their profits in Q4

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The massive fraud involving billionaire jeweller Nirav Modi and Punjab National Bank (PNB) is a blow that could bring the banking system to its knees.

Much has been said about how much PNB would make good the loans that its peers have given to Modi’s companies based on fraudulently issued letters of undertaking.

But, irrespective of whether banks or even PNB get back their dues, all lenders having direct or indirect exposure to the clutch of companies declared as fraudulent will have to make 100% provisioning in the fourth quarter of 2017-18.

The four companies that have been declared as fraudulent are Gitanjali Gems, firms of the Nirav Modi group Stellar Diamonds, Diamonds R us and Solar Exports.

Gitanjali Gems, one of the companies that is said to have defrauded PNB, has a total debt of Rs7,185 crore as of last September, largely bank loans and guarantees. There are no public records available on the debt of the other three companies. However, a Reuters report citing income tax department documents said that Indian banks have extended loans and guarantees totalling Rs17,600 crore to these four companies as of March 2017. Other media reports suggest banks’ total exposure to the companies excluding Gitanjali Gems could be as much as Rs7,800 crore.

This puts the additional provisioning of roughly Rs15,000 crore due to the fraud. Banks are required to provide 100% towards exposure to companies declared involved in fraudulent transactions.

The figure is not paltry when juxtaposed against the roughly Rs70,000 crore provisioning banks did in the September quarter towards bad loans.

While wounded lenders would suffer more pain, the government will have to deal with the embarrassment of its recapitalization money going down the drain.

Even this is not the worst. The gems and jewellery sector, especially companies involving sprucing up rough diamonds, is a sensitive and opaque segment for lending.

Entities involved with precious gems can also easily be a front for money laundering and tax evasion, given the large amount of cash transactions being done. Also, aside from such conjectures, the value of the underlying precious gems is also volatile and valuing them is tricky.

In the case of the fraud involving PNB, the income tax department has found the companies to have produced inflated invoices, apart from other financial transgressions.

Banks have been historically cautious in lending to these companies and the exposure to the gems and jewellery sector has never exceeded over 3.5% of total bank loans in the past decade.

The fact that such caution was thrown to the winds while lending to Nirav Modi’s companies and his associates underlines the criminal negligence in basic lending protocols and the disturbingly familiar collusion between bankers and high-profile borrowers.livemint