Why RBI regulation is must for gold loan firms?

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Why RBI regulation is must for gold loan firms?

The glitter of gold loans has grown exponentially in the past five years. From a Kerala specialty the industry now has drawn into its fold hundreds of NBFC’s who in turn draw funds from zillions of retail investors, mutual fund investors and banks.

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The glitter of gold loans has grown exponentially in the past five years. From a Kerala specialty the industry now has drawn into its fold hundreds of NBFC's who in turn draw funds from zillions of retail investors, mutual fund investors and banks.

This week there was news that the RBI is seriously looking to introduce some prudential rules and customer protection guidelines. CNBC-TV18's special show Indianomics Latha Venkatesh discusses if the exponential growth already making the sector a bubble? So is it time the RBI steps in, if yes, in what fashion.

In the first place regulator like the RBI is unlikely to have the wherewithal to be able to monitor customer practices across the length and breadth of the country, that's going to be RBIs first big challenge. The second big challenge will be to ensure that the industry remains and that the baby is not thrown out with the bath water.

Joining the panel are Prithvi Haldea, Prime Database and Unnikrishnan, the Managing Director, Manappuram Finance .

Here is an edited transcript of his comments. Also watch the accompanying videos.

Q: Do you think it is time to put in some rules in this sector?

Haldea: To begin with this industry has moved from typically unorganized rural pawn broker kind of situation many years ago to an organised corporate sector activity. That's good because you can have better practices and more transparency there and better regulation. But at the same time we have also seen that when any activities get corporatises it can lead to its own ills.

The concern, that I have, is that in the financial sector especially when any industry or any part of the financial sector grows beyond the normal rate of 15-20% it should be a cause of concern.

This industry has been growing exponentially and there are now many players across the country and the regulator is more in terms of the NBFC prudential norms rather than regulating gold as a collateral and the practices associated with gold.

So, the regulator is breaking up. If I go historically lets take the example of plantation companies. I still remember that the first two three companies which came to the market were all very good companies. They had projects in hand and had good schemes.

Once they caught the fancies of the investor then we had thousands of plantation companies coming to the market.

And the damage had been done before the regulators woke up and when finally when the regulator woke up they came up with such stringent guidelines that the entire industry got killed. I am glad that they are waking up and they would put prudential norms in place so that the industry survives and it is not either allowed to grow the way it is growing or it has killed through over regulation.

Q: I just want to know some of the ground rules on which the sector works not just your company. Usually what is the loan to value - do you keep a 10%-15% margin. Secondly what is the effect of rate of interest if you count penalties for late payment? What is the average annual interest rate that the sector charges not just your company?

Unnikrishnan: What the sector charges is something around 20%-22% annualised that too we need to look at slightly differently because when bank charges interest they charge on monthly compounded basis. For gold loan companies it is annual simple rate at that rate that is 20%-22%. The difference between monthly compounding and annual simple is around 2%. So, when we say we charge a mixed rate of 22%, actually in banks terminology it is only 20% that also we discount this because we do not levy any prepayment penalty on the customer.

Q: What about the margining? How much of a margin set up and what is normally the industry practice?

Unnikrishnan: Industry practice among the NBFCs is they go up to 85% of the scrap value of gold. When I say scrap value it is the ornament price minus making charges that is 15%, minus impurities is the price of the gold, is the market value of the scrap on which we take a cut of minimum 15%, maximum could be anything. On an average this margin is around 20% to 25%.

Q: That looks like there is a fair safety in terms of margin even if the gold prices were to crash, but let me come to the other issue of customer protection. Have you from your network of sources heard of any sharp practice in terms of customer protection. Is there any safety in terms of the customer definitely getting back the same ornament that was mortgaged?

Haldea: Let's take this discussion to the industry as a whole and not company because as I said there could be a couple of good companies and we should not tarnish their image. What I am hearing is not about just the top one or two companies, but about other companies, which have strung up in the last few years.

Now a couple of things, which have come to the forefront is for example concern has been raised even by the regulator as to what is the end use of this money, unlike other loans where you are buying a house or a car or any other asset.

This is basically cash for cash in a sense and you could be blowing up this money in the bar or just spending it for no productive purposed. Therefore that should be an area of concern especially in case you have instances now where a husband steals the jewellery of his wife pawns it and then uses up that money for all his extracurricular activities in a sense. There are also concerns about theft of gold by both the employees as well as third parties.

There are instances where the ornaments have been changed. There are instances where lesser number of ornaments then what was pawned are being shown and worse is I think there is a systemic failure in case you do not pay up on time, the companies have a right to auction.

Now I do not know whether this auction process has been defined in terms of regulation by any regulator? Does anybody monitor the auction? Does anybody look at the auction proceeds? Because what I understand is that most of these auctions are done within the group companies and proper notice is not given to the borrower.

The companies may inform him late or may not inform him and the customer may not actually remember the date on which he has to repay and a lot of gold goes for auctioning where obviously the companies charge an extra piece of money for auctioning process and the investor therefore gets even lesser money.