As Indian economy embarks on Unlock 1.0, the big challenge for individuals and businesses is the availability of adequate funding to bridge the revenue gaps. In this light, gold loans have emerged as a viable and workable alternative.
Rush for gold loans
The gold loan market was dominated for a long time by the non-banking gold finance companies. The likes of Muthoot and Manappuram from Kerala were the undisputed names in the business. In India, nearly half the gold loan business is unorganized in the sense that it is outside the RBI regulated channels. In the post-COVID scenario, most banks are bracing themselves for a spurt in gold loan demand. It is easier to get and also safer for the banks to disburse as it is back-to-back lending.
Gold loan arbitrage
One of the reasons gold loan companies like Muthoot have performed so well in the last few months is the renewed demand for gold loans. Most families have a stash of gold and Indian homes are estimated to own 22,000 tons of gold worth a whopping $1.3 trillion. For the financers, it is essentially a secured arbitrage business. They are able to refinance gold at much lower rates and lend at much higher rates. The risk of delinquencies is low as it would mean a slump sale of your gold. Most gold financers make the most of this spread.
There is the risk of regulation
Since gold loans are still a small part of the loan portfolios of banks, RBI has not been too stringent about regulation. But we have seen in the case of MFIs that when the going gets tough, the RBI will not hesitate to tighten regulations. For example, if gold becomes volatile, RBI may choose to reduce the LTV to 50% from the current level of 75%. The RBI can insist on higher capital adequacy requirements for gold loans and that can also change the economics of gold loans substantially. As of now, the RBI does not see too much of systemic risks to the financial systems but things could change if volumes pick up sharply.
What if gold prices fall?
That is the bigger risk in the gold loans business. The higher LTV of 75% on gold is made possible only because gold prices have been stable over time or they have been appreciating in value. But there have been long spells of down movement in gold. For example, between 1980 and 1999, gold moved from $950/oz to $240/oz. Similarly, between 2011 and 2015, gold fell from $1850/oz to $1050/oz. These are the kinds of price movement that change the economics of the gold loan business drastically. If global growth picks up, gold prices could crack and gold loan calculations could go for a toss. Banks need to be wary of the price risk that is implicit in the gold loan business!
