Banking and credit are the fuel that keeps the diamond industry moving. Like so many other businesses today, without access to credit and liquidity, the diamond industry would grind to a halt. However, in recent years, credit has become more challenging than ever before, as banks have become more stringent in their lending requirements to diamond businesses, and as they have increased the level of transparency and accountability needed to access funding. Credit needs extend across the entire spectrum of the industry, from mining to retail, and affect everyone in between, especially manufacturers and traders. Let’s take a closer look at this vital support system, and how we got to where we are today.
In many transactions, big and small, payments are made in cash. While this used to be very common, society as a whole has been moving away from the use of cash for many years, as electronic payments have become easier and more secure. Many countries have banned cash payments in excess of a few thousand dollars, and cash deposits and withdrawals beyond a minimum threshold often garner scrutiny from banking and commercial institutions, which are required to report such transactions. Many countries have begun to phase out their highest denomination bank notes, such as the 500-euro note, which will be gone by 2018. In India, the 1,000 and 500 rupee notes were removed from circulation in November 2016 to battle the undeclared economy, and recently a new 500-rupee note was introduced. In many places around the world, retail outlets no longer accept even modest denomination notes for fear of counterfeiting.
This move towards a cashless society has meant that banking has a wider and deeper role in day-to-day transactions. The 2008 global financial crisis set off a period of banking turmoil and instability. With it came the third amendment to the Basel Accord, Basel III. The Basel Accord is a set of voluntary requirements on banks in G20 countries that created a framework for the amount of capital banks must hold to guard against their own financial and operating risks.
As banks began implementing Basel III, they started placing requirements on their own clients, and shifted many of the new obligations onto them. Among these clients are diamond companies. Many of these companies are located in the mid-section of the diamond pipeline, and often operate with extremely thin margins. Because they buy and sell a very high-cost product that leaves only a small margin, diamond firms are highly leveraged, and the debt to asset ratio of many diamond firms fell below the Basel III requirements. The implementation of Basel III, which places a large emphasis on debt to asset ratio, meant an extensive change for many diamond companies, which had to adjust much of their financial model in order to meet new lending regulations.
This meant that many heavily leveraged diamond companies were in trouble. This ultimately led to a number of bankruptcies, something that deeply shook the diamond industry. Diamond companies had to finance more of their operations using their own funds, and many could not maintain these requirements, and were forced to exit the business altogether. Some of the major diamond producers, most notably De Beers, supported these financing changes, and have been slowly implementing them in their own client selection process. De Beers now requires all of its Sightholders to adhere to minimum International Financial Reporting Standards (IFRS) and its best practices to maintain rough supply. Those companies that had already taken steps to improve their internal financial controls and reporting standards were in a much better position to prosper under the new framework.
However, the new global banking environment had some unpleasant impacts on the diamond industry. Belgian bank KBC was forced to divest its Antwerp Diamond Bank (ADB) division after receiving a $4.4 billion bailout package from the Belgian government in 2008. ADB was a massive lender to the diamond industry, and held an estimated $1.8 billion in loans in 2013. After a long period of looking for a potential buyer, KBC elected to wind down operations and close ADB along with its loan portfolio. This created an immense liquidity issue in Belgium that has still not been fully rectified today. Some other banks have stepped forward to fill the gap left by ADB, but the industry in Belgium has suffered the most from the loss.
Some Indian banks jumped in to support the industry, and their clients at home. To promote exports, the Indian government requires local banks to set aside a certain percentage of their lending towards exports. This was a great benefit to the diamond industry in India, which is largely geared towards manufacturing and exports to other consumer countries. However, a problem arose after the removal of import duties on polished diamonds, when a practice known as ‘round-tripping’ started to take hold. This essentially meant that companies exported diamonds, allegedly making fictitious sales, and then re-imported them, repeating the practice several times to create an inflated and artificial turnover of goods. Since banks would lend to these companies against sales invoices, liquidity flowed into the companies that allegedly participated in this fake trade.
Seemingly, much of the extra capital was not fully being invested in diamonds. Instead, much was siphoned out of the industry and invested into other assets, such as real estate and equities, because those areas were more profitable. So, the value that companies were willing to pay for rough diamonds became heavily exaggerated, as the value in diamonds was no longer about manufacturing them into polished stones for the jewelry industry, but was rather linked to getting cheap financing that could be invested elsewhere. This access to cash had another negative impact on the diamond industry: the excess funding allowed companies to pay more for rough diamonds, apparently leading to massive price distortions, especially in smaller goods that could be bought in large volumes.
Inevitably, though, banks got wise to what a small number of their clients were doing, and began requiring full transparency and accounting to international standards. Notwithstanding these hiccups, the diamond industry still must have access to credit. Most diamond dealers, wholesalers, and retailers usually buy and sell polished diamonds on 30 to 90 days credit. In order to sell their goods, manufacturers must be able to support operations on a longer-term basis and generate regular turnover to maintain cash-flow. Without financing, only a few companies will be able to survive.
To provide such credit, the diamond industry will need to address the needs of the banks and their new limitations, and instill in banks confidence in providing credit to the diamond industry as a whole. Many banks have expressed a disinterest in lending to the industry, at least until there are more stringent standards of reporting. The industry is changing, albeit slowly. We have seen a move towards shorter payment terms, decreased inventories, and more internal capital used to finance growth. These are positive changes for the long-term health of the diamond industry.
Banks want to finance quality assets and quality operations, and some companies in our industry may not be able to adjust to the new mold. The current situation in the industry, with rough and polished diamond prices in disequilibrium, and companies buying rough at a loss just to maintain turnover, is not helpful, and will not drive more banks into providing financing for the diamond industry. The industry still has work ahead to align itself with the new global paradigm in banking and risk. We have seen in just the past few months that even some of the largest manufacturing companies in the world are not immune to banks seizing their assets because of over-leveraging. The trickle-down effect of these losses is felt by all, and will only exacerbate banks’ fear of lending to the diamond industry.
The views expressed here are solely those of the author in his private capacity. No one should act upon any opinion or information in this website without consulting a professional qualified adviser.
Diamond industrialist Ehud Arye Laniado is a man passionate about diamonds. From his early 20s in Africa and later in Belgium honing his expertise in forecasting the value of polished diamonds by examining rough diamonds by hand, till today four decades later, as chairman of his international diamond businesses spanning mining, exploration, rough and polished diamond valuation, trading, manufacturing, retail and consultancy services, Laniado has mastered both the miniscule details of evaluating and pricing individual rough diamonds and the entire structure of the diamond industry. Today, his global operations are at the forefront of the industry, recognised in diamond capitals from Mumbai to Tel Aviv and Hong Kong to New York.