A diamond expert studies a diamond under an electronic microscope. The global demand for gems and jewellery witnessed a moderation in 2015 after strong growth from 2012 to 2014 (AFP /Image for representative purpose only)

In Mumbai’s diamond trading circles, pudiya ghumao (which literally means “pass the packet”), the colloquial term for round-tripping of diamond consignments from one market to another, ostensibly to artificially inflate company balance sheets, isn’t exactly a secret.

While the finer details of the Nirav Modi case are expected to be known in due course, several people with knowledge of the matter whom Mint spoke to, said that his alleged fraud came to light only after he failed to secure fresh loans to service his existing debt.

According to the people cited above, Modi had been trying to raise money for more than two years and had repeatedly approached several private equity funds, offering to sell a controlling stake in the company, and was also considering an initial public offering, but remained unsuccessful.

“I first met him many years ago when he had approached us for a Rs 2.5 crore loan,” said one the persons, a former banker. “He had started his own company after initially working with his maternal uncle Mehul Choksi, chairman of Gitanjali group. But in the next few years, his business grew and so did his loan book, as he began borrowing aggressively from many other banks. “Most of these loans were pre- and post-shipment credit facilities from banks in India. These loans are essentially working capital loans taken on the basis of current assets where the borrower has to only keep paying interest while the principal is rolled over at the end of the tenor by the same bank or a new bank,” he added.

The global demand for gems and jewellery witnessed a moderation in 2015 after strong growth from 2012 to 2014. In 2015, the global demand for diamond-studded jewellery was around $79 billion, after touching a high of around $81 billion in 2014. The sluggishness in diamond jewellery demand continued in 2016 with marginal improvement in the intermediate quarters of the year, but again dipped in early 2017. The year 2016 also saw a seven-year low in global demand for gold jewellery.

However, according to Care Ratings, the share of the gems and jewellery sector in the total credit exposure of banks to industries remained in the range of 2.5% to 3% during this period, often clocking higher than industry average even though working capital cycles and leverage parameters worsened.

Further in FY15, profit margins exhibited a drop as the industry saw players offloading their inventory at lower price levels. The drop in margins continued in FY16.

“It’s safe to say that a portion of these loans were availed by artificially inflating the balance sheet, typically by showing bogus trades of the same consignment of diamonds between shell companies that are controlled by related parties,” said a second person, a former senior employee of a large diamond trading company.

Some of the loans taken were diverted to unrelated businesses from day one, the second person said, adding: “Things were fine till the repayments were happening on time but once banks realised the problem, they began tightening the lending norms and in some cases completely stopped lending altogether.”

But some banks found themselves compelled to keep lending because they had very little collateral to begin with and knew that stopping credit would mean risking the entire loan as an NPA (non-performing asset). Political clout of the diamond lobby was another reason why banks, especially public sector ones, could not stop lending, maintain industry watchers.

“The choice was sometimes between a remote posting or turning a blind eye and many bankers chose the latter,” said the first person. Modi’s case, although the biggest in terms of size, is not an isolated one.

In April last year, the Central Bureau of Investigation (CBI) registered six cases of alleged fraud against Winsome Diamonds Group for allegedly siphoning off Rs1,530.44 crore in loans to three public banks — Central Bank of India, IDBI Bank and Vijaya Bank. Again in 2010, a consortium of banks led by State Bank of India approached the Reserve Bank of India after JB Diamond, which figured among India’s top 10 diamond firms, defaulted on Rs800 crore of loans taken from Indian banks . The Times of India reported that the firm had diverted the loan to illegal investments.

In 2013, Surat-based Vincent Diamonds defaulted on loans to the tune of Rs 4,500 crore to Indian banks.

Jatin Mehta, promoter of Winsome Diamonds and Jewellery Ltd, has since renounced his Indian citizenship to become a citizen of the Federation of St Kitts and Nevis.

Former employees of Modi’s company Firestar Diamond describe him as someone who did not allow free exchange of information even within his own business teams. He spent his time between his New York, Mumbai and Antwerp offices and took all business decisions personally. Rough diamonds were procured from Russia, Sierra Leone, and Armenia among other places and mostly sold in Belgium. Some diamonds were imported into India and made into studded jewellery and exported back to various locations abroad.

“It was hard to know the scale of the business,” said a former Firestar Diamond employee. “Unlike gold which has a standard price, the valuation of diamonds is a grey area. Valuations can greatly differ depending on the cut and clarity, among other things. Therefore, there is no sure-fire way to tell the value of a diamond consignment. It’s an industry practice to under-report the value of a consignment,” the former employee said.