Indian Exporters Blame Banks as Derivative Losses Threaten Ruin

Indian Exporters Blame Banks as Derivative Losses Threaten Ruin

By M.C. Govardhana Rangan

April 28 (Bloomberg) -- Jasmin Mehta says that when he told salesmen from ICICI Bank Ltd. he didn't understand currency derivatives, they chauffeured him to a hotel and bombarded him with charts showing how his company could make a profit with zero investment.

Three months later, Mehta, then chief finance officer of Sundaram Multi Pap Ltd., told his chairman that two of the contracts had turned sour, incurring losses of 60 million rupees ($1.5 million). ICICI has served a bankruptcy notice to collect the money, Sundaram says.

``I was made to believe these bets don't go wrong,'' says Mehta, 33, a commerce graduate from Mumbai's Dalmia College. ``It was all about making profit, no mention of losses.'' ICICI, India's second-biggest bank, denies misleading its customers.

Indian companies may lose $4 billion on derivatives, according to Hong Kong-based brokerage CLSA Ltd. Sundaram is among a dozen firms that have filed lawsuits against banks including ICICI, Kotak Mahindra Bank Ltd. and Axis Bank Ltd., accusing them of hiding risks to lure small businesses into contracts they didn't understand. No rulings have been issued.

``There's a lack of transparency at banks,'' says Gautam Rao, director of Business Risk & Hedge Management, a Chennai- based consulting firm. ``They don't explain the various legs of the transaction. The companies have no clue what they're doing.''

Derivatives are financial instruments used for speculation and as insurance against fluctuations in the markets. Their value is based on prices for currencies, stocks, bonds, loans and commodities, or linked to events such as changes in foreign exchange rates.

Fully Aware

The banks say clients were fully aware of the risks.

``We maintain records to show that companies knew what they were getting into,'' says Madhabi Puri Buch, an executive director at ICICI who declined to comment on specific cases. ``There were no complaints when they were making profits.''

In Sundaram's case, ICICI has a signed contract and the recording of an Oct. 24 phone call in which Mehta says, ``Yes, yes, yes, I agree,'' according to papers filed at Bombay High Court.

Indian banks may lose 16 billion rupees if they can't enforce the contracts with smaller companies, according to CLSA, the Asian brokerage arm of French investment bank Calyon. The estimate is based on the assumption that 10 percent of companies may renege on the agreements.

ICICI declined to comment on potential losses for its clients on April 26, when the bank reported earnings. Axis Bank, India's fourth-largest by market value, set aside 719.7 million rupees for possible losses April 21.

``We are still contesting that,'' said Axis President Hemant Kaul. ``Our claims are good and solid.''

Central Bank Guidance

In April 2007, the central bank issued guidelines stipulating that banks should sell derivatives only to investors who ``understand the nature of the risks.''

Some complaints about malpractice in the sale of derivatives are under investigation, central bank Governor Yaga Venugopal Reddy said March 31, without naming the banks.

``As long as the Reserve Bank of India guidelines are followed by banks, in letter and spirit, there should be no scope for dispute,'' Reddy said.

Indian exporters were persuaded to buy the contracts as insurance against currency fluctuations after the rupee registered its biggest quarterly gain in 34 years in the three months ended June 30, reducing earnings from overseas.

``Some greedy companies played into the hands of greedy banks,'' said Arunthangam, a former banker who runs ATM Tex, a garment exporter based in Karur, and uses only one name. ``I didn't take any contracts because I knew they were risky.''

No Business

Sundaram, which has no business in Switzerland, paid nothing on Oct. 24 when it bought a contract betting on the Swiss franc's value against the dollar. On that day, the franc traded for 1.17 to the dollar, according to data compiled by Bloomberg.

The contract guaranteed Sundaram $36,000 as long as the franc was valued at more than 1.23 to the dollar within a month, according to the company's lawsuit. If the Swiss currency appreciated past 1.095, a record high, in three months, Sundaram would have to buy $6 million at 1.23 francs to the dollar.

The franc rose to 1.08 on Nov. 20 as concerns about a U.S. recession lured traders to the Swiss currency. A second contract with a $22,000 potential profit also turned into a loser, forcing Sundaram to buy an additional $7.5 million at 1.23.

ICICI demanded 60 million rupees, more than Sundaram's annual profit, to cover the losses.

Refused to Pay

After Chairman Amrut Shah refused to pay, the bank threatened to force Sundaram into bankruptcy and liquidate the company, Shah said in an interview.

In response, Shah filed his lawsuit accusing ICICI of not adhering to the central bank's guidelines about explaining the risks of derivatives.

While Mehta was removed from his post after the losses came to light, Shah doesn't blame his former finance chief for the possible closure of his firm, which he started as a bookbinder 25 years ago with a few thousand rupees.

``We trusted the biggest name in the banking industry,'' he says. ``It has led to this mess.''