A funding crunch may finally force India’s secretive diamond industry to become more transparent

The secrecy-obsessed Indian diamond industry, which accounts for 14 out of every 15 diamonds polished globally, is being forced to open up. The trigger is money: with traditional banking routes closing down due to concerns over mounting defaults, the $12-billion sector has to become more transparent to be able to tap new fund sources.

Finance is key for the Indian diamond sector, which cuts and polishes a billion pieces every year. It raises around $6 billion from India and $5.5 billion from international banking channels annually, according to the Gems and Jewellery Export Promotion Council, an industry group.

Largely owned and controlled by the Palanpur Jains, a close-knit community whose reach extends from Gujarat’s Surat to Antwerp in Belgium, it has mostly thrived on close business relations. Not unlike the old Jewish families that earlier dominated the trade.

There is an unwritten code among these families that encourages only close relatives and brethren to be part of the trade so that profits stay within the community.

Rough diamonds are mined in Africa, bought and sold in Antwerp, shipped to India for cutting and polishing and then exported to the luxury markets of Europe and the US for retail sale. The buying and shipping of roughs is typically done by family members who then ship the uncut stones to their extended family in India. These families own cutting and polishing units in Surat, India’s diamond hub, where skilled labour costs one-tenth of that in Europe and a fourth of China’s. Thus, a single entity can oversee the entire chain after mining, and reap the profits.

Losing shine

However, all that is set to change. The global economic slowdown, falling demand and, most importantly, mounting defaults by some companies in the Indian gems and jewellery industry have given banks the jitters. Most of these lenders are already reeling from large-scale defaults in other industries.

ABN Amro, Antwerp Diamond Bank, and Standard Chartered are among those who have either stopped lending to the sector or have significantly reduced their exposure to the business.

“There is the possibility that more banks may follow suit and exit this business,” said Anoop Mehta, president of the Bharat Diamond Bourse, a special exchange set up for the buying and selling of diamonds. “There is now the need to look at new finance options. But for that, diamond companies will have to become more transparent and open up.”

That is easier said than done.

For decades, most of these family-owned diamond firms have operated informally. Business orders were relayed by word of mouth while transactions were maintained through old, dense methods of book-keeping. Even buying and selling was done with informal cash payments made across cities by using select codes, a practice known as the angadia system.

“Even the old Jewish families that had moved to Belgium were ‘informally’ promised tax incentives by the then government, prompting these families to move from Israel to Belgium for the lure of easy business,” said one Mumbai-based trader who asked not to be named.

Such opacity just won’t cut it anymore. Accounts will have to be maintained and more disclosures, on the lines of corporate announcements made by listed companies, will have to be made. “The world is anyway moving toward such a system by having adopted global accounting systems,” said Bharat Diamond’s Mehta.

Banking methods such as channel financing and peer-to-peer lending, which are used internationally, will have to be adopted, in place of the more traditional method of collateral-based lending, where some asset is taken as security and a loan provided based on its value.

Under channel financing, a group of banks provide finance to all players in the entire chain of the diamond trade so that the flow of business is sustained. Peer-to-peer lending is primarily a low-cost online lending method.

“Large finance firms and even Indian financial institutions have been looking at these options. In fact, some firms have even tied up about $200 million to $300 million through channel financing,” said GJEPC chairman Praveenshankar Pandya.

But banks have been cautious as some of the larger firms had recently defaulted or have been hauled up for evading taxes. Last month, the Indian Express reported that the income tax department had conducted surprise surveys on the offices of the Gitanjali Group, one of India’s largest diamond companies.

“It’s an evolving industry now in India,” said Ernest Blom, president of the World Federation of Diamond Bourses and a veteran of the trade. “If smaller and mid-scale firms have to be brought up, then banks must also come forward to guide them.”

This article first appeared on Quartz.