Business Today

Penalty corner

Suman Layak        Print Edition: May 29, 2011

Subramanian Dhananjayan, a chartered accountant in Tirupur, Tamil Nadu, had a busy second half of April, advising members of the Forex Derivatives Consumers' Forum from all over the country. The forum had been first set up by small companies based in Tirupur, who had bought exotic derivative products in 2007 from different banks and were trapped in the not-so-fine print of the complex products they never understood.

Renowned for its hosiery and knitwear products, which it exports across the world. Tirupur is a small town with an unusually high concentration of rich traders. But the ones among them who had bought the forex derivatives suddenly discovered that far from having made any money, they now owed crores to the banks. They also found they were not alone. Entrepreneurs from across the country came clamouring to join the forum, as banks got after them, seeking settlements.

No saving grace
The banks the RBI hauled up seems to include everybody
"Now we know why the banks were so keen to settle the disputes," says Dhananjayan, referring to the April 26 decision of the Reserve Bank of India to levy a penalty on 19 banks for selling such products. The list of banks named by the RBI reads like the who's who of Indian banking . The RBI said in its press release that the penalties were being levied for "failure to carry out due diligence in regard to suitability of products, selling derivative products to users not having risk management policies and not verifying the adequacy of underlying and eligible limits".

Forum members have been sufficiently emboldened to say they will file claims for damages. The forex derivative products were essentially contracts signed between the banks and the companies, taking bets on different global currencies like the Swiss franc, the Japanese yen and the euro, without any assessment of the underlying foreign exchange exposure of the buyers' businesses or their foreign exchangerelated risks, which were mostly US dollar-linked. The products were also sold not as risk management products but as schemes that could add to the profits of the companies. While the first few months brought in some profits, as international currency market trends turned, the contracts started to clock losses. The banks' losses were limited within the contract. But the buyers' losses had no limits and quickly ran into crores. In a nightmarish spiral, the banks reported them to the Credit Information Bureau as defaulters, which led interest rates on their existing loans being increased and practically snuffed out their chances of getting future loans.

"We were ignorant and the banks took advantage of us. Luckily, we could organise ourselves," says Raja Shanmugham, president of the forum, who acknowledges the support of Swadeshi Jagran Manch activist S. Gurumurthy.

E. Palanisamy, an entrepreneur whose company Armstrong Knitting Mills had run up a debt of Rs 27 crore, says banks are now ready to settle for much less. "They were earlier asking me to pay 40 per cent of their claim," he says. "Now they are asking for 30 per cent only. But after the RBI decision, I will not accept it."

"Men in suits and ties came to Tirupur from big cities to sell us these products," he adds. "They have now run away, and local branch officials are trying to find a way to settle." Meanwhile, following a public interest litigation filed by a Cuttackbased taxation expert, Prabhanjan Patra, the Orissa high court has ordered a Central Bureau of Investigation probe into the forex derivatives. The banks, through their associations like the Fixed Income Money Markets and Derivatives Association of India, and the Indian Banks Association, have appealed against the order in the Supreme Court. The appeal is still pending.

"The banks have lined up the top lawyers of the country," says Manoj Kumar Mishra, who represents Patra. "But the RBI decision had substantially strengthened our position." The plight of Tirupur's traders has also attracted media attention in South Korea, where a similar product called the Kiko wreaked havoc in the nation's small scale sector. The Kiko - or kick-in kick-out contracts - were suspended by Korean courts in 2009. Over 500 Korean companies had recorded a total loss of $1.2 billion on these contracts till 2008, with many filing for bankruptcy.

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