Diamonds and Dirt: Discomfort in the World of Comfort Letters

By Samit Aich, CEO, S3IDF India

The zeros are multiple and they just don’t seem to end. At last count, it was pegged at INR.11400 crores (roughly $ 1.77 billion) and is seen as the largest banking swindle that has hit India in recent times, thanks to some suave duping self-anointed haut diamantaire named Nirav Modi. Indeed, such a gem of a fraud!

True to tradition, Nirav Modi (aka NiMo) has flown out of the country well in time and presumably landed in New York City, watching the fun on TV. Knives are drawn and politicians of all hues and tinges are doing what they do best — playing politics. Meanwhile the average depositor of Punjab National Bank, (the government bank which has been primarily defrauded ), is queuing up more worried about AADHAAR number linkages with their bank accounts, lest their hard earned money gets ‘frozen’. This is thanks to the constant sms reminders they get from their bank, threatening them with money laundering charges, in the case of account non- linkages by 31st March 2018. What depositors should be actually more worried of is for their hard earned monies possibly disappearing into the thin air — thanks to fancy scammers like NiMo and his ilk. And in the meantime , the Financial Resolution and Deposit Insurance Bill is also being debated upon as to whether the princely sum of INR.1 lakh (roughly $ 1500/-) for depositor insurance pay-outs is sufficient enough, in case a bank goes bust. Such is the irony of our times!

The core of the NiMo transaction is the Letter of Undertaking — a fairly routine transaction in banking systems around the world. It simply means that one bank tells another bank across borders, that it will meet its customers’ liability in case of a default. This is somewhat akin to a ‘Comfort Letter’ that banks sometimes accept, albeit within borders, as a condition towards extending a loan. Anyone who has a rudimentary experience of the Indian banking system will know of the otherwise enormously frustrating experiences an average entrepreneur goes through, to access credit for one’s small business unsecured loans — particularly from public sector banks.

True, at the end of the day, no bank can afford to have NPA’s and defaults. Banks are not charitable institutions- they are business entities and expected to generate net positive returns. But banks, especially government owned ones, are also mandated to extend loans to the priority sector on easier terms in India. In the last few decades, an enormous amount of good work has been carried out on this front in India and banks as a whole have done significantly exemplary work of extending loans to deserving communities. Successive governments- both central and state, have also pitched in by designing innovative schemes that allow for access to capital for small businesses and entrepreneurs. But a lot more needs to be done, can be done and must be done.

Comfort Letters are perfectly valid transactions in the banking system and there are numerous examples of such letters being utilised and help secure capital for businesses all around. And ‘business’ doesn’t mean multi-billion dollar businesses but enterprises that are small, tiny and on the fringe of the formal-informal economic system.

Let me give you the example of Krishna. He runs a waste business in Bangalore, received (along with several other informal waste entrepreneurs) an overdraft from Vijaya Bank, a government bank that is headquartered in Bangalore, India because of, well, a Comfort Letter. Another key player in this exemplar is the National Safai Karmachari Finance Development Corporation (NSKFDC) which is under the aegis of the central Ministry of Social Justice and Empowerment. This is an apex corporation that is focussed on all-around socio-economic upliftment of the Safai Karamcharis, Scavengers and their dependants throughout India, through various loan and non-loan based schemes. Vijaya Bank is the intermediary bank that refinances these NSKFDC loans at subsidised rates ( 6%) to these targeted beneficiaries ,who are essentially informal small scale waste entrepreneurs .

As a bank, Vijaya Bank is well within its rights to ask for some form of guarantee or security for extending these overdrafts to these informal waste entrepreneurs. The Small Scale Sustainable Infrastructure Development Fund (S3IDF), an international development organisation that focuses on systemic financial inclusion for informal entrepreneurs’, played a catalytic role by convincing one of its mission aligned social business partners to issue a Comfort Letter to Vijaya Bank to securitise these overdrafts (each worth about INR 100000/- roughly $ 1500/). Basically, it meant that in the event of default, the social business partner will buy out the waste inventory from the informal waste entrepreneur, thereby de-risking Vijaya Bank in the eventuality of default.

Two relatively rare events have occurred in this example. One, certainly within Vijaya Bank (and perhaps within any Indian public sector bank), is that waste has been seen of being of commercial value worth being monetised and eligible for an overdraft via a guarantee, aka a Comfort Letter. Two, the overdrafts issued by Vijaya Bank to these informal waste entrepreneurs are on a minimum balance savings account. An overdraft issued on current accounts for formal businesses is the usual norm but these particular overdrafts are for these waste informal businesses, is an exception and not the rule.

True, this is a perfect storm where a government bank (Vijaya Bank) and its progressive General Manager realised the actual needs and credit worthiness in an informal waste business , a government corporation (NSKFDC), with an incredible mission, devised innovative financial mechanisms, a social business enterprise stood in as a guarantor via a comfort letter, and an ecosystem catalyst (S3IDF India) played the role of stitching all of this together to make the unbanked waste worker, bankable.

So what does all this mean in the contrasting world of diamonds and dirt?

That for every Nirav Modi, there is also a Krishna. For every suave swindler, there is an honest entrepreneur. For every unscrupulous haut diamantaire out to hoodwink, there is a scrupulous waste worker who ekes a living the honest way. Banks needs to learn from these experiences and not get into knee jerk mode by squeezing capital access to the small informal entrepreneur whilst dishing out billions of public money to scammers masquerading as business tycoons. A significant section of India’s population is engaged in the informal economy — they don’t need doles or charity, they need enterprise support and an ecosystem that encourages inclusive market systems.

Perhaps then, Comfort Letters may not be such uncomfortable letters!