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Scandal in the Warehouse

Petty traders defraud top banks in a major commodities scam. Shantanu Guha Ray takes the lid off the stink

Naorem Ashish
Most of the warehouses had undersized or substandard stocks. Yet receipts were issued and loans sanctioned
Warehousing is a bad word if you are a small or medium-rung trader in India. The chances are that both you and the warehouse owner will be under the scanner and checked repeatedly by banks and other agencies before being certified for business. This is because the risk perception of the commodities market across India has heightened following a scam that has made many sit up and take notice, especially in Mumbai that is home to some of the biggest exchanges.

India’s second largest bank ICICI Bank has already taken a hit on loans given against warehouse receipts (WR) — a pledge security which acts as evidence that a specific commodity is kept in a warehouse.

Sources told Tehelka that the fraud, unearthed in the quarter ended December 2006, is in the region of Rs 500 crore.

ICICI Bank has officially admitted that the loss is close to Rs 100 crore, but sources in the commodities market say that the figure is easily double since more names continued to haunt the markets as late as March-end this year. A few public sector banks were also affected. ICICI Bank’s total portfolio of warehouse receipt financing is at around Rs 1,600 crore, which is around 13 percent of the total agri-portfolio of Rs 12,313 crore.

ICICI Bank and other banks work closely with India’s largest agriculture commodities exchange, the National Commodity and Derivatives Exchange (NCDEX), to enhance their presence in WR finance. In fact, this is one of the new businesses that constitute a slice of the farm-lending portfolios of private sector banks like ICICI Bank, Rabobank and hdfc and public sector banks like State Bank of India in the past couple of years.


‘The commodities market in Mumbai is a volatile place. We are on high alert when it comes to this market’

ACP Sadanand Date, Economic Offences Wing

“The warehouseman assesses the quality of goods tendered and checks its specifications on the warehouse receipt. But in this case, nothing was done. A group of traders and bank officials colluded to dupe the banks. We have made more than 20 arrests, including 11 traders and bank officials and have sealed properties. The chargesheet has been filed in court,” says sub-inspector Wagh Chawre of Maharashtra Police’s Kolhapur Crime Branch, who investigated the case.

Traditionally, commodities are stored in state and Central government warehouses. However, in recent years a string of private warehouses has also come up. In case of private warehouses, banks appoint collateral managers. These managers, who have expertise in bulk commodities, certify the goods and monitor their movement, and mark interest in the books of warehouses — the lien of the bank, among others. In some cases, private warehouse players also act as collateral managers. But the banks often resort to cost-cutting while hiring managers.

Banks also appoint management and collection agents to help identify borrowers for warehouse financing. In some cases, these agents also store the receipts on behalf of the bank. Bankers admit this is as one of the major loopholes in the system.

Sources said that in Maharashtra, one of the state government warehouses was involved in the fraud, while in other states, management and collection agents were involved. In most cases, the quantity mentioned in the receipts did not match what was in the warehouse.

“ICICI Bank officials discovered the fraud in the course of a routine audit. The Reserve Bank of India has already been apprised of the matter. The bank has been able to recover a part of the money. It has access to guarantees, land and also cash as collateral from these agents, and has also taken over the control of the commodities in the warehouses,” the sources added.

The interest rate in financing of warehouse receipts is between 8.5 percent-13 percent. Unlike loans against dematerialised shares where the presence of depositories acts as a comfort to the bank, in case of WR financing, banks hire collateral managers who check the quality and quantity of the stock against which the loan is disbursed. “The fraud happened since some of the collateral managers colluded with the warehouses to issue WRs which showed inflated or non-existent stocks. Warehouse owners in as many as four states — Maharashtra, Madhya Pradesh, Rajasthan and West Bengal were involved,” says Chawre.

WR financing is a commodities-based financial instrument that brings more interest revenue to the financiers. It gives farmers the option of holding back their produce if the prices are low and get up to 80 percent funding of the value of their produce from banks. A WR guarantees the existence of a given quantity and quality of a commodity in storage for safekeeping, often used in cash and futures transactions.

Investigations by the Kolhapur District Crime Branch reveal the presence of a significant number of small and medium-scale warehouses.

Collateral managers and traders colluded with warehouse owners to get bogus warehouse receipts to defraud banks
Warehousing is big business. For the record, WRs from NCDEX have doubled in one year by Rs 5,000 crore to Rs 10,000 crore in 2005-06. And what’s more, banks are lending against WRs at an attractive rate of 8 percent-10 percent. “We are being extra cautious and putting more stringent norms in place,” quips Narendra Gupta, chief of strategy, NCDEX.

Investigations revealed the bulk of the warehouses not having the required stocks of wheat and rice. Some had substandard stocks that shocked the investigators. In normal cases, banks do their own due diligence before issuing loans against WRs but somehow the effort was not made. “The case was pursued and investigated by the Kolhapur District Crime Branch. We have not heard of Mumbai warehouses involved in this case,” additional commissioner of police (economic offences wing), Sadanand Date told Tehelka.

NCDEX is aware of the issue and its implications on the markets. ‘‘The onus lies more on the banks. Their collateral managers need to be more vigilant,” adds Gupta.

There are goods worth Rs 500 crore-Rs 1,000 crore at NCDEX warehouses at any given point of time with over 1 lakh metric tonnes of physical delivery happening every month. It is five times the number with other warehouses, owned by private players and state governments. “Hopefully, the swift action against the erring traders and warehouse owners will send a strong message to those planning similar rackets,” adds Gupta.

‘This was the same way Big Bull Harshad Mehta raised money against bank securities,’

says a police official

“We are trying to put into place a foolproof system with an extra controller on the ground so that there are more checks and balances for these godowns,” says Hari Prasad, managing director of National Collateral Management Services Limited (NCMSL), a subsidiary of NCDEX which controls nearly 500-600 godowns across Rajasthan and Madhya Pradesh.

Top police officials in Mumbai feel that the scam was hushed up to prevent further shocks in the markets. “On the face of it, no big names have come up. But we are investigating as to whether the money was routed back to NCDEX. This should be taken as an alarm call. Let us not forget that this was the same way Big Bull Harshad Mehta used to raise money against bank securities,” adds one top cop.

Mehta’s activities that ranged in the region of Rs 4,500 crore was unearthed by sleuths from the Securities and Exchange Board of India and the finance ministry way back in 1992.

A look at the volumes exposes the gravity of the situation. NCDEX records a daily turnover of around Rs 3,000 crore. The total margin deposits with NCDEX at a given point of time is around Rs 1,000 crore. Out of a total margin deposit of Rs 1,000 crore, around Rs 300 crore-Rs 400 crore is in the form of cash deposits. If bank funds to the tune of Rs 500 crore, siphoned off through deliberate and well-planned fraud in the WR financing system, has found its place in the margin deposits with NCDEX, as soon as the fraud is blown such money will either be forfeited or will be used towards meeting the default and scam liabilities. In such a case, the entire NCDEX market may collapse, because the major chunk of NCDEX cash margin deposit (ranging around Rs 300 crore-Rs 400 crore) will be completely wiped out in the process.

“We are keeping a close watch on the commodities market,” says Date, adding: “It is important to put checks in place immediately. The commodities market is an important place for top-end financial transactions, and today the futures exchanges are increasingly looking towards farmers’ participation for their success and to drive the volume turnover.”

As funds seamlessly flow from one market to the other and the Indian commodities market begins to integrate with the global market, stock market analysts feel that the risk perception is beginning to heighten.

“Clearly, trade volumes are set to expand rapidly. Demand for a wide variety of commodities covering food, fibre, metals and energy will surely expand,” says noted market analyst Hemen Kapadia.

He should know. An inter-ministerial task force headed by RCA Jain, additional secretary in the finance ministry, has targeted Rs 7,000 crore worth of pledge financing by 2006-07. But the recent scam can surely put the clock back. “It is not something the markets wanted when the government was keen to push the banks to lend money against WRs,” says Rajesh K. Srivastava, director, Rabo India Finance Private Limited.

Analysts say that the problem should not be viewed in isolation as merely a problem of non-performing assets of Rs 300 crore. Rather, it should be viewed in a wider perspective. Sums up market analyst Suman Kapila: “This should be a wake-up call for NCDEX while handling physical deliveries and WR financing to prevent culprits gain major market share.”

May 12 , 2007

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