What role does bank financing play in today’s diamond industry? Bank financing is the lifeblood of the industry. Without it, there would be no money for exploration or new store openings.
A sector of the diamond pipeline where financing is especially essential is the midstream. Financing enables the purchasing of rough diamonds, expansion of manufacturing plants, procurement of new machinery, accumulation of large and diversified stocks of polished diamonds, and investment in R&D.
Financing is crucial given the nature of diamond manufacturing. This is because rough is purchased for immediate payments to miners, while it takes months to polish and certify diamonds only to be sold for 60, 90 or even 120 days of credit. The message is clear: financing keeps the industry ticking.
However, it seems that financing terms do not carry the same regulatory and industry banking obligations everywhere. This means that financing is more difficult in some centers than in others.
There used to be two main banks that financed the diamond pipeline, and several more that specialized in the industry and provided additional financing. They were ABN AMRO, Antwerp Diamond Bank, Union Bank, ICICI, Bank Leumi, Israel Discount Bank (IDB) and, later on, Standard Chartered.
Today, the landscape has changed. ABN is reducing diamond industry financing, ADB closed, Leumi has opted out, Union has reduced financing too as has ICICI and Standard Chartered. At the same time, Indian banks – which do not necessarily specialize in financing the diamond pipeline – are supplying financing to Indian diamond companies.
Increased global oversight
The global financing world has been under much stricter scrutiny in recent years, since the September 2001 terrorist attacks and especially since the Lehman Brothers financial collapse in 2008. This has led to tighter oversight and demands for much greater transparency.
Among the new regulations are the Basel Accords: Basel I, Basel II, and most recently, Basel III. Each of these agreements added a series of regulations on banks, with Basel III, drafted after the 2008 economic crisis, aimed at improving the banking sector's ability to absorb shocks by improved risk management and governance, and increasing banks' transparency and disclosures. One of the measures involves requiring banks and their clients to meet a stricter asset-to-borrowing ratio.
By the time Basel II was applied, banks that provided credit facilities to diamond companies had understood that "old school” rules no longer applied, and much more transparency and stricter requirements for collateral valuations were implemented. This included AML requirements with regard to the source of funds and other related matters.
The above trend has been on the rise since the 2008 credit crunch and financial crisis. In that sense, Basel III is not so much an innovation as an evolutionary outcome of Basel II. This means that banks are much more cautious and now refuse credit facilities that are not guaranteed by correctly valued collaterals and where information provided with respect to AML requirements is not sufficient or clear enough.
In practical terms, this has meant that banks must now exercise far more caution in their lending policies. This results in increased spending on client oversight, which leads to costlier operations. These added costs make borrowing more expensive and complicated, as costs are shifted to borrowers in the form of higher interest rates. Furthermore, borrowers are required to prepare themselves internally and make necessary arrangements, which adds further costs to their lending needs.
As Erik Jens, ABN AMRO’s head of Diamond and Jewelry Clients, explains, banks are more critical with funding decisions and are looking for a greater level of security against their loans, driven in part by the quality of financials reported across the midstream.
The Basel III demands have also meant that borrowing firms must provide more assurances to banks and now have access to less financing for the same level of assets. Moreover, as noted above, the cost of this financing is higher because of the banks’ increased costs.
It is obvious that the application of these regulatory requirements do not apply equally to all participants in the diamond pipeline (namely debt to equity requirements, proper valuations of collateral, recognition of income, full transparency).
Not all diamonds centers are alike
Financing is provided to the diamond industry in a variety of ways: loans, buying credit, revolving credit against sales, and more. Often financing is provided against collateral – assets owned by the diamond company, such as offices i.e., real estate. In the past, and still today to a certain extent, this financing was provided against diamond inventories. Since the 2008 crash, however, this form of collateral has been reduced. Today, the emphasis is on real estate and receivables. This collateral comes along with requirements to submit audited financial statements complying with IFRS reporting standards.
This situation applies to most countries around the world today. However, in India for example, diamond companies are benefiting from a unique form of financing. There, a law requires banks to earmark a percentage of their credit portfolio to exports. Many Indian banks choose to meet this requirement by providing financing to diamond firms. This has raised a question for many in other diamond centers: how to cope with the significant financing provided to the Indian diamond industry, to which they simply do not have access.
While companies in the West are closely scrutinized by authorities and subjected to rules and regulations, Indian companies have easier access to funding thanks to laxer regulations. While in Belgium, Israel and New York, diamond companies must hold assets and stand bare in front of the banks with very detailed documentation about their day-to-day operations, their Mumbai counterparts receive financing in much more favorable conditions, such as credit facilities against business projections.
And herein lies the problem. This state of affairs harms serious traders – around the world as well as in India. Healthy competition is simply impossible.
Excess capacity of financing
The issue is not just that this situation is not “fair.” The divergent levels of financing constitute a serious game changer. The current level of financing exceeds the actual commercial needs and thus opens the door to soaring prices of rough, as money is no longer an object. The market’s need to maintain the right balance between supply and demand is violated, in every sense of the word.
This leads to a situation in which demand for the product is lower than the capacity that firms that "enjoy" excess financing have the potential to supply. The diamond trade’s massive inventories are partly a result of over-capacity built on excess financing.
The situation does not end with clients. At a certain point it rebounds back on the banks when firms do not have the ability to fulfill their obligations towards financers.
When a company has excess capacity of financing, it is likely to deprive funding from a company that could utilize it more efficiently. It reroutes needed money, blocking its flow to other firms.
In actuality, the easy access to financing has allowed firms to overpay for rough diamonds, which leads to runaway rough diamond prices. Mining companies capitalize on this situation by milking such firms for huge profits – while most manufacturing firms continue to languish near the break-even point.
Illusions, big and small
Companies that have easy access to cheaper money take steps to increase their market share. For larger companies, this gives them the illusion that they can take business from hard-working companies with less access to capital.
On the other hand, when this easy money lands in the hands of smaller firms, it gives them the illusion that they are strong, established firms, which they are not. And yet they try to act the part. For instance, they will buy rough diamonds in large quantities to demonstrate their financial ability, driving prices up to the point that is no longer economical.
These companies have not learned that when you buy rough diamonds, you should already have the asset backing from their polished. It is a hard lesson to learn. And apparently some are yet to learn it.
Traditional firms – those that started small, learned, developed slowly, gained experience and knowledge, expanded a little, learned more, added a few more activities and grew more until they became mid-size and large companies – have learned how to handle themselves with a long-term view. They have detailed balance sheets and a history of activities that allow banks to assess their credit worthiness easily and accurately. The banks carefully scrutinize them and their inventories, which are put up as collateral. Their financing is in line with their abilities, activities, assets and receivables. They are responsible firms.
Conversely, those firms that inflate instantly to mid-size and large companies have not had the chance to learn from their own mistakes. They do not have much experience and the leap in size presents them with challenges that they do not know how to meet. Their banks, which among other faults, often do not specialize in the diamond industry, do not know how to scrutinize their assets.
A side effect of this is that such diamond firms’ lending banks might find themselves with non-performing assets more often than their more prudent counterparts.
Conclusion: responsible practices for a healthy industry
The current situation is harming the industry. Rough prices are driven up, polished diamond prices driven down, and good diamond firms are out of business. Banks in India must adhere to global oversight standards, and the leadership of the diamond industry must take a stronger stand against irresponsible practices.
The diamond industry should continue to be interested in better financing standards. This will allow us all to get a fair share of the financing pie. We need to catch up to the banking requirements and raise the bar for transparency in our activities – with our financing banks and with our colleagues up and down the pipeline. We could then expand by creating alliances and consolidating. Most importantly, we need to increase confidence in our industry and among our potential consumers, for ultimately it is they who guarantee our livelihood.
The views expressed here are solely those of the author in his private capacity. None of the information made available here shall constitute in any manner an offer or invitation or promotion to buy or to sell diamonds. No one should act upon any opinion or information in this website (including with respect to diamonds values) without consulting a professional qualified adviser.