Why is RBI worried about gold lending practices, and do they impact the market?
“All that glitters is not gold.”
You might have heard this idiom quite a lot of times in a lot of situations. Well, this time, the message from the Reserve Bank of India is loud and clear. Let me explain: the central bank has recently flagged irregularities in gold lending practices that could threaten the integrity of the gold loan market in India.
Gold lending practices have been a concern for RBI for a while, and it has taken action in the past to regulate the market from time to time. Recently, RBI barred non-banking financial company (NBFC) IIFL Finance from sanctioning, disbursing, or selling any of its gold loans this year due to “significant deviations” in its gold loan portfolio.
Striking gold: The rise of gold loan market in India
The gold loan market in India is predominantly controlled by the unorganised sector, which holds a 63% share. At the same time, organised players, including banks and NBFCs, account for the remaining 37%, according to a PwC report. However, in recent years, organised players, particularly NBFCs, have begun to gain market share.
Demand for gold loans has increased exponentially, with an estimated market valuation of Rs 6 lakh crore in 10 years (grown at a rate of 12% CAGR) due to rising gold prices and easy access to loans. This has also introduced lending risks that the RBI now seeks to mitigate.
Furthermore, interest rates on gold loans are relatively lower than other types of loans, making them attractive for those in need of quick cash. The current interest rate on gold loans is 9.15% p.a. onwards, with a loan amount of up to Rs.1.5 crore for a minimum 3 months’ tenure. Here’s a lowdown on gold loan interest rates of top banks:
Note: Above illustration is for information purposes only and is not exhaustive. GST will be applicable on processing fees.
RBI’s action
So, what has RBI’s ears ringing on the gold lending methods?
On September 30, RBI released a notification that mentioned it has identified some concerning irregularities in the way certain supervised entities (SEs) grant loans against gold ornaments and jewellery, basically gold loans. It has issued a 3-month ultimatum to these banks and NBFCs to strengthen their gold loan policies.
These irregularities include shortcomings in using third parties for sourcing and appraisal of loans, valuation of gold without the customer’s presence, inadequate due diligence and lack of end-use monitoring of gold loans, and lack of transparency during auction of gold ornaments and jewellery on default by the customer.
RBI also stated a problem with the loan-to-value ratio or LTV. LTV is the percentage of the loan amount compared to the value of the gold one is pledging. According to RBI guidelines, the loan-to-value (LTV) ratio cannot exceed 75%. This implies that if the gold is valued at Rs 1,00,000, the upper limit for the loan is Rs 75,000.
However, the cost of the loan is subject to change given the price of the gold, which the banks are supposed to monitor periodically. RBI noticed it was not being followed. “System-generated alerts, where available, were not pursued actively to address the breach in LTV ceiling,” the central bank stated.
Here’s a snapshot of RBI’s diktat
Impact on Gold Loan Market
While RBI is doubling down on serious lending malpractices, the move highlights its intention to protect the overall gold market. It believes that such tight measures will safeguard the financial system and prevent a build-up of bad debts in the long run. RBI aims to ensure the integrity of these lending practices to bring stability to the banking sector.
Listed companies with high compliance should not see much impact from this. However, these checks may weigh on the growth of some of the listed banks and NBFCs with a sizeable gold loan book, such as Muthoot Finance and Manappuram Finance, which may experience increased stock volatility in the near term as lenders will likely go slow in growing their gold loan book to focus more on meeting higher compliance standards.
The next three months are, therefore, crucial for the banks as they chalk out plans to comply with the regulator’s diktat and strengthen their gold loan operations.
Dos and Dont’s of Taking a Gold Loan
What happens to gold investments?
A more stable gold lending market can improve investor confidence in gold as an asset, too, with fewer security risks.
Historically, gold has proven to be a safe haven in times of market volatility and economic instability. In the short term, gold and stock markets indicate a negative correlation. In times of recessions, such as the 2008 economic crisis, gold stood out regarding returns and performance. On the other hand, during the stock market bull run in 2014, gold underperformed, and prices dipped. A similar trend has been seen in the last 6 years as well, even in relatively short-term periods of volatility in the stock market (see chart below).
At the same time, in the long term, gold and the stock market have a positive correlation. Gold has continued to provide stable returns with a CAGR of over 9% in the last 10 years, only slightly lower than Nifty50 at 11%. (see chart below).
Overall, gold is an excellent complementary asset to hold along with stocks. Exposure to this asset class is becoming increasingly relevant given the relatively high volatility of Nifty in the last few years due to the pandemic, volatile political conditions in Europe and the Middle East and uncertain economic conditions in the developed world, especially in the US.
A regulated and stable gold sector reduces risks for both lenders and investors. With this diktat, investors may reconsider their approach to gold and explore financial instruments like Gold ETFs, smallcases, and other financial products linked to the precious metal. To build a stable all-weather portfolio, check out some of our smallcases like All Weather Investing and Equity & Gold. You can explore them here.
Disclosures for aforementioned smallcases
Disclaimer: Investment in securities market are subject to market risks. Read all the related documents carefully before investing.Refer to our disclosures page, here.
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