A Banker’s Doublespeak
March 12, 09There are plenty of instances in which a diamantaire tries to take his bankers “to the cleaners.” There are instances where an insolvent diamantaire will pay all his debts in the trade and leave the banks waiting until there is nothing left with which to pay. There are rare instances in which it is the other way around, instances in which a bank may act unscrupulously (maybe even fraudulently) to ensure that a customer’s default is avoided by various “borderline” practices.
I recall the crisis of the early 80s when many clients were problematic. A bank would sell off the diamond collateral of a defaulting client at a below market distress price to another problematic client whose insolvency was avoided in this way. Illegal? Probably not. Dishonest? Absolutely. Bankers may sometimes cross moral, ethical or even legal borders in order to rescue a problematic client at the expenses of an innocent third party.
These cases are seldom documented, seldom proven and seldom reach a courtroom. This makes a court verdict in a case of alleged banker dishonesty in a Tel Aviv court case against the diamond branch of the First International Bank of
The events took place six or seven years ago (the timing is relevant as the operational risk controls banks now have in place were not as stringent then as they are today). The then manager of the branch, Rachel Kagan, whom I have personally known for well over 25 years, has been found guilty of intentionally giving false information about the credit worthiness and good standing of a client. Five diamond companies and/or their bankers were told that a specific company was in good standing and a good risk for high amounts. At the time Kagan gave out that information she knew that the relevant company was already in trouble and had been placed on an internal watch list of problematic clients.
By encouraging other diamantaires to give her client credit, she enabled an improved cash flow in the troubled account, so when the (maybe unavoidable) moment of default arose, the bank’s exposure was less than it would have been if a handful of other diamantaires had not given credit to the client. The “crime” was that of giving good information on a not-so-good client. In one way or another, such “crimes” probably happen many times a day around the world. Bankers are acutely aware of the potential legal consequences of “badmouthing” a customer. If a client is considered a “bad risk,” in many instances the banker may have made an error in judgment in providing credit to begin with. No bank is in a hurry to broadcast its own failure in judgment.
The case in the Tel Aviv court involves issues that banks classify as “operational risks.” This term refers to the potential “direct or indirect banking loss resulting from inadequate or failed internal processes, people and systems, or from external events.”
When a Singapore-based rogue trader in the Barings Bank’s local branch brought down the entire bank, this was a classic case of poor operational risk management and risk controls. The derivatives trader should have been caught, assuming the bank would have wanted him to be caught, because often the official breaking the rules, or exceeding authority, does so to benefit the bank rather than him or herself.
That brings us to the case deliberated in the Tel Aviv court, which is a classic case of what I would call the “risk appetite” level maintained by either the bank or individual managers. In the lending business, a bank must take risks in order to earn profits; defaults are part of that business. Actually – and this sounds hard to believe – if a bank’s loan delinquency rates are consistently below a certain industry average, the banks credit policies may well be too strict and good business was likely turned away. For a bank it is easy to turn business away; the challenge is to successfully support the growth of the businesses of one’s clients. Write-offs are expected as the price of doing business (and are often unavoidable when clients fail to survive economic or business shocks of the type faced by many global borrowers today.) But when they are the result of faulty operational risk controls, such as sloppy lending policies, faulty internal decision-making processes, this requires banks to take a hard look at their own internal procedures.
Most of the time the question is where the line is being drawn, although in this case the court found it was clearly over the line. Saying that a client is in good standing when he is already problematic, involves a risk. However, saying that a client is not a good risk and his credit worthiness is low, may actually ruin that client’s business. Most of us would immediately sue our bank if it were to give out negative information about our businesses. Whatever a banker says about a client, it must avoid triggering a damage claim against the bank by the client. The key challenge facing a banker giving out information on a not-so-good client is how to do so without putting the bank at risk.
Use of Code Words
I remember from my own banking manager days of decades ago that bankers like to use codes that are well understood among bankers, but sound innocent enough from an outsider’s perspective. If one had a lousy client and wanted to give a negative recommendation to another bank that made the inquiry, you would use a sentence such as, “we have known this client for many years, he is a highly respected and decent businessman who usually meets all his obligations.” The term “usually” is the giveaway. It means “not always.” It means “not.”
A good banker will know that this is a highly negative recommendation, but the client could never come and sue the bank for having said something bad about him.
Israeli newspapers, commenting on the case of the First International Bank of
Kagan is a darned good banker, she knows her business better than most others, but nevertheless she got into problems. There are really two issues here: (a) the level of operational risk controls within diamond banking on the one hand, and (b) the reliance of diamantaires on the opinion of a third party bank for their own corporate credit decisions. Do we truly expect a banker to say that the creditworthiness of its own client, who is good enough to get money from the bank itself, is not good enough to get credit from a third party?
It is a common practice for banks to issue minimum information about clients in the course of normal commercial relations. Strictly speaking, because of banking secrecy, a client must agree (preferably in writing) that his banker gives information to a third party. In practice, an interested party will ask his/her bank to contact another bank. Also in practice a client in good standing will generally be very happy that the bank gives a positive recommendation. The conflicts only start when a client has become problematic but is still solvent and active. Here is where the intentional ambiguity comes in. If a banker has nothing good to say about you, he will probably politely point out that “all my clients are excellent but I cannot say a word about this specific client without first having his prior written approval – something that I do not have at the moment.” That is already a giveaway.
When a client had some checks bounce in the past and his banker is asked if a check ever bounced the banker would most likely reply “I can’t really remember. He has been a good client for so many years.” A tricky situation arises when a banker asks his colleague if a certain check will be honored. In some instances the banker might say that such a check is in the scope of the approved facility, but they also may ask that the check be presented in the normal way. That may also be a giveaway. Bankers have their own language, and the sin of Kagan was not only that she misrepresented the true situation of the client, but that failed to protect herself and the bank by the blunt and straightforward language she apparently used. Banking is definitely not a business for straight shooters. They must be diplomats.
A banking official giving out wrong information is just one minor part of the operational risks a bank faces, but it is a part that is hard to control. The new Basel II capital adequacy requirements imposed on the banks have issued myriad strict rules governing “operational risks.”
When a bank forgets to bounce a check within the allowable period and is stuck with a few million dollars loss, because of its own administrative error, this is one type of loss caused by bad operational risk control. Intentionally misrepresenting the credit worthiness of the client is partly an operational risk, and partly a commercial risk.
Banks want to make money. Jeopardizing their relationship with a client by telling “the truth” about him, may lead to a closing of the account. That is not a desirable business outcome for a banker. Nevertheless, there is now a clear regulatory obligation on the banks to set strict norms about what can and should be said.
Then there is the client side of the diamantaires. The inevitable lesson of the case of Kagan should be that diamantaires must do their own due diligence when checking the credit worthiness of a potential client. They must understand that information released by a bank on the credit worthiness of a client is problematic in almost any event. They should also resign themselves to the unmistakable fact that in the diamond business the information in the hands and the heads of the traders is often far, far better than any facts one would ever get from a bank. The fact that in the FIBI case, five highly reputable and experienced diamond firms relied so much on what the bank said is, by itself, quite surprising. It doesn’t justify what the bank did, but it may not have been wise to rely so much on what was said.
Bankers Visiting De Beers in
Last week, we mentioned that for diamond bankers to sit together in breakup groups to discuss several aspects of lending, compliance policies and lending models in general, seems to be patently illegal. We cautioned bankers to take toothpaste and toothbrushes with them in the case that regulators would show up as uninvited guests to the bankers meeting organized by the DTC.
I am pleased that DTC Managing Director Varda Shine has assured me that this was all a misunderstanding and that there will be no breakaway sessions for bankers on the agenda of this seminar. The two versions of the invitation will be amended and instead the program will feature a guest speaker in the vacated time lot. No attempt will be made to discuss any new lending models, as was initially suggested, except maybe for something in the most general terms. That was a very pragmatic and wise decision. We now change our recommendation and suggest to all the bankers to leave their toothpaste and toothbrushes at home.
Have a nice weekend.