Credit must be given where it is due: the diamond industry has managed to increase its trade through 2010 and the first quarter of this year - at close to or beyond pre-downturn levels - working with less bank financing than before, Avi Krawitz says in his article posted on www.diamonds.net. This is the mark of a far healthier industry, albeit still with significant challenges.
As explained in the April edition of the Rapaport Diamond Report, the reliance on less credit is not only the result of cautious bank lending. Sales terms within the industry have become shorter and diamantaires have injected more of their personal capital into their businesses. In addition, more trade is being done on a cash basis today than before, particularly due to a focus on the more cash-oriented Far East market, but also because dealers and wholesalers in the U.S. have reduced their memo sales.
Still, the industry can always do with an infusion of more capital to boost activity. Industry representatives, particularly in Belgium and Israel, are lobbying the banks to increase their lending. In Israel for example, they argue that while rough imports rose 30 percent and polished exports by 32 percent in 2010, bank credit rose just 6 percent to about $1.6 billion by year end. Lending was at about $2.6 billion in 2008.
However, the argument may not be reasonable given the dramatic change in the way the banking sector operates since the downturn. In fact, the nature of the downturn, and its impact on the diamond industry, was such that lending practices were probably too high to begin with. Even so, the banks themselves are operating in a different regulatory landscape with Basel I, II and soon III dictating tougher terms for their clients and requiring stronger collateral. Basel also makes the banks insistent on better transparency from the industry.
Not that the banks were especially burned by the industry during the downturn. Most agree that the number of bankruptcy and defaults was relatively small among diamond companies, particularly in light of the decline in trade and consumer demand. This fact has spurred some confidence among the bankers post-crisis. However, the nature of their work is to be prudent and conservative, and it is unlikely that they will increase their lending without good reason.
The banks want to see low inventories and a high turnover of goods - indeed the hallmarks of a healthy diamond business. These are factors that they will be looking at as the recovery progresses and as diamantaires request more funding. The banks stress that if the turnover is there, the funding will come. Rising inventory levels, they note, could signal warning bells that a company may be making speculative purchases in order to hold onto goods in the expectation of higher prices down the line.
For this reason, the industry stood in good stead at the start of 2011 as polished inventory levels were, and continue to be, relatively low – perhaps even too low given the shortage of goods on the market and that manufacturing appears to be lagging. However, reports that rough inventory levels are rising will do little to encourage a more liberal lending policy from the banks.
Increasingly, banks are lending based on invoices and are reluctant to fund inventory purchases. The exception, in all centers, appears to be larger dealers and manufacturers, where banks reportedly finances some Diamond Trading Company (DTC) sight purchases, as well as the Indian banks, which appear to be more lenient in their practice.
As a ‘priority lending’ export sector in India, banks lend to the diamond industry at a discounted rate and do so liberally to fill their priority-lending quotas. As a result, there are some 60 to 80 banks providing credit to the industry in India, making funds more readily available and also providing Indian companies with cheap money to invest elsewhere. In addition, large volumes of rough are being double- or triple-traded, creating receivables for other businesses, thus resulting in an inflated sense of demand and unrealistic price levels.
The market therefore should view the current level of activity in the rough market with caution, in the same way that the more conservative banks in other centers are likely to. The banks, as the industry should, will want to see more rough being filtered to be polished to balance out the excess of rough apparent in the market and the undersupply of polished.
And while diamantaires will argue that they need the funding to help grow the industry, it appears there is sufficient financing fueling the trade at the moment. An influx of additional large-scale funding would certainly encourage the speculative bubble in the rough that some fear is looming. The industry would be well advised to focus on keeping inventories low and turnover high so that the banks can continue to give credit, where it is truly due.
