Mumbai: 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 profit with zero investment.
Three months later, Mehta, then the chief financial officer of Sundaram Multi Pap Ltd, had told his chairman that two of the contracts had turned sour, incurring losses of Rs6 crore. ICICI has served a bankruptcy notice to collect the money, says Sundaram. “I was made to believe these bets don’t go wrong,” says Mehta. “It was all about making profit, no mention of losses.” ICICI, India’s second biggest bank, denies misleading customers.
Fencing accusations: ICICI Bank officials claimed they had records to prove that companies knew what they were getting into. The bank said it had not received any complaints when the companies were making profits. (Photo: Rajeev Dabral/ Mint)
Indian companies may lose $4 billion (Rs16,000 crore) 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 attract small businesses into derivative contracts that they didn’t understand.
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.
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, 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 a 24 October phone call in which Mehta says, “Yes, yes, yes, I agree,” as per papers filed at the Bombay high court.
Indian banks may lose Rs1,600 crore if they can’t enforce the contracts with smaller firms, according to CLSA. The estimate is based on the assumption that 10% of firms may renege on the pacts.
ICICI declined to comment on potential losses for its clients on 26 April, when it reported earnings. Axis Bank set aside Rs71.97 crore for possible losses on 21 April. “We are still contesting that,” said Axis president Hemant Kaul. “Our claims are good and solid.”
In April 2007, the Reserve Bank of India (RBI) issued guidelines stipulating that banks should sell derivatives only to investors who “understand the nature of the risks”. Some complaints about malpractices in the sale of derivatives are under investigation, RBI governor Y.V Reddy said on 31 March, 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 30 June, reducing earnings from overseas.
Sundaram paid nothing on 24 October when it bought a contract betting on the Swiss franc’s value against the dollar. On that day, the franc traded at 1.17 to the dollar. The contract guaranteed Sundaram $36,000 as long as the franc was valued at more than 1.23 to the dollar within a month, the company’s lawsuit said. 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 20 November as concerns about a US recession attracted traders to the Swiss currency. A second contract with a $22,000 potential profit also turned into a loser, forcing Sundaram to buy $7.5 million more at 1.23. ICICI demanded Rs6 crore, more than Sundaram’s profit, to cover the losses.
After chairman Amrut Shah refused to pay, ICICI threatened to force Sundaram into bankruptcy. In response, Shah filed his lawsuit accusing ICICI of not adhering to RBI’s guidelines about explaining the risks of derivatives. “We trusted the biggest name in the banking industry,” Shah says. “It has led to this mess.”