Banks adopted various ways to sell illegal and ‘exotic’ derivatives in their profit pursuit, bypassing the Reserve Bank of India’s (RBI) guidelines and causing losses of as much as Rs34,000 crore,

Banks used exotic means to hoodwink Reserve Bank

Banks adopted various ways to sell illegal and ‘exotic’ derivatives in their profit pursuit, bypassing the Reserve Bank of India’s (RBI) guidelines and causing losses of as much as Rs34,000 crore, which they then tried to cover up by forging documents, DNA investigations have found. Banks sold these contracts to gullible companies, taking advantage of a depreciating dollar against the rupee, and offering exporters what they needed — an alternative to offset their currency losses. In 2007, the rupee rose rapidly to Rs39 from around Rs50 per dollar, causing panic among Indian exporters who feared loss of revenue - they were getting less rupees for their dollars. And as the dollar continued to fall, banks started wooing clients via e-mails, even sending company executives on free holiday trips to Singapore, Thailand and South Africa to convince them to buy these derivatives. DNA has access to several such e-mails and documents which show how banks brazenly violated RBI guidelines. In 2006 and 2007, under the pretext of a conference, ABN Amro took executives on a free five-day tour of Thailand and Malaysia. “The conference was attended by about 100 such representatives of several companies from India where they were explained about derivative (exotic) products,” as per an affidavit by I Venkateswarlu, executive with Tiruppur-based Armstrong Knitting Mill. DNA has reviewed the affidavit. Subsequently, he bought these derivatives in 2007, which led to a loss of Rs27 crore. S Dhananjayan, a chartered accountant from Tiruppur, said two of India’s biggest banks took their clients on a fully-paid trip to Cape Town, South Africa, Singapore and other places. Some banks even put up hoardings in Tiruppur emblazoned: “Suffering from forex losses? Come to us, we have a solution”, while others preferred to draw customers by sending personalised e-mails and attractive presentations. Banks’ particular interest in Tiruppur companies can be attributed to the fact that Tiruppur is a leading source of hosiery, knitted garments, casual wear and sportswear exports for India, and therefore, a major source of foreign exchange for the country. The city accounts for 80% of India’s cotton knitwear export, worth an estimated US$2 bn. Besides Tiruppur, exporters in Mumbai, Hyderabad, Ahmedabad and a few other cities were also targeted by the banks to sell exotic derivatives. Early 2007, Rajith Kumar Naidu of State Bank of India, Chennai, sent an e-mail to a Tiruppur-based exporter saying, “Please find attached some very interesting structures with potential to earn huge profits... Please call me for further clarification.” In the next e-mail, Naidu claimed that these derivatives have “strong possibility of making profits”. Further, banks used a template of contracts to avoid procedural delays and finalise the deals quickly. For instance, ICICI Bank signed a contract which was meant for a company with a Tiruppur-based partnership firm to quickly set the process rolling. In many cases, even the important sections of the contract agreement were left blank. DNA accessed many copies of such contracts. The other strategy that banks followed was holding exclusive seminars on how derivatives are an easy option of making profits and offsetting losses due to fluctuating forex rate, said Dhananjayan. The RBI guidelines said banks should carry out due diligence to ensure that each derivative transaction is suitable and appropriate to a customer’s requirements. However, none of these banks followed it in principle, and encouraged corporates to sign deals that were purely speculative in nature and, without a doubt, inappropriate for the business. In this regard, the RBI had written a letter to CBI on October 27, 2009, listing 10 rules, under the Foreign Exchange Management Act and RBI, which these banks flouted while selling derivatives during 2007-08. Since the deals were formed without underlying assets, as soon as the issue was highlighted in media, banks made traders sign some underlying papers to cover up the fraud. For example, one R Senthilvel of ABN Amro, sent an e-mail on November 7, 2008, to Cylwin Knit Fashions of Tiruppur, saying “Take printouts of the attached (an order sheet document of an unknown trader) and affix a seal of Cylwin and sign and give to us.” However, the order sheets were not pertaining to Cylwin at all. If that were not enough, banks forced and intimidated exporters to sign documents at the end of the financial year 2009 in a rush to convert derivative losses into corporate loans. “In fact, in one exporter’s case, the documents converting the loss into a loan were signed at midnight on March 31, 2009,” said Raja Shanmugam, president of Forex Derivative Consumer Forum. In 2009, the central bank directed all the banks to maintain a separate account for losses due to exotic derivatives, yet many banks didn’t. DNA is in possession of many letters exchanged between SBI and exporters, where exporters appealed to Tiruppur branch of SBI to implement the RBI direction, but the largest public sector bank did not. The matter has been pending with the Supreme Court for more than two years now.