Gold loan deep dive: Banks in retreat, but no cakewalk for Manappuram, Muthoot

What are the factors underpinning the gold loan business in India?

They are what I call a poor man's credit card. In India, we have only around three crore people who have credit cards from these large banks. For somebody who does not have a credit card, gold is the easiest source of money. He goes to a gold loan company, and says: “Here is my gold, and I need Rs 1 lakh rupees.” The bank will check the value of the gold and lend him money without asking how he intends to spend it. In short, a gold loan is a no-questions-asked loan.

One concern we hear from some investors is that because of increasing financialisation, gold will become a less attractive asset class to own. And that does not bode well for gold loan companies.

I don’t agree. Gold loans are still very popular today, and I think they will always remain relevant. That’s because, in India, a large section is not covered by the ICICIs and the SBIs of the world in terms of credit. And that won’t change anytime soon.

Where do NBFCs score over banks in the gold loan business?

The business is branch-driven. Two, NBFCs are much faster than banks when it comes to disbursing loans because that is what they do day in and day out for a living. An NBFC is open between nine in the morning and six in the evening. Even if you walk in with gold at 5:45 in the evening, you will walk out with cash the same day. That is not the case with most banks, because their branches do not service gold loan customers alone.  You have to make an appointment, the valuer will come, and then you will get the cash.

Some banks are doing this in a dedicated way; for example, the Catholic Syrian Bank has invested in this and has the same resources as gold loan NBFCs. So, they seem serious about the gold loan business. It would be wrong to say that all banks cannot compete with NBFCs. Those banks for whom gold loans are important, will do well.

You mentioned a branch network. But most banks have a much better branch network.

In a branch, every day 100 people will come; they will queue up with their gold. Now, imagine a top-tier private sector bank. They are trying to make priority banking loans, and sell wealth products on one side; and on the other side, there are 50 people in the branch coming for gold loans. It does not look well for their own branding.

Also, the gold loan customer is not someone polished, wearing branded clothes and all that. He can be a shopkeeper or somebody who is in the scrap business or some small businessman. It is difficult for banks to have a very dedicated approach like the gold-focused NBFCs. For banks, gold is just one of the many products they offer. So, they will grow along with the market, but I don't think that they can really do what the NBFCs can do.

Shares of gold loan companies have done well of late. The talk is that competition is not as intense as before as banks have stopped getting aggressive. Why is that?

That is because the gold loan business runs down very fast; the average maturity of gold loans is five months. If a bank has a Rs 100 crore book today, and if it does not take any new loans for the next five months, its loan book will run down to zero. So it is like a treadmill, and not every bank likes to run on a treadmill because they can easily give a Rs 40-50 lakh LAP (loan against property) or a home loan and grow. In comparison, gold loans are of much smaller ticket size, even if more profitable.

Why did banks get into gold loans in a big way?

Banks became aggressive in 2011-12-13 when gold prices went from Rs 8,000 to Rs 30,000. (The higher the gold prices, more the money that can be loaned out for the same quantity of gold). After 2014, gold price remained in the 25-30,000 range 2018-19. So many banks exited. In 2013, Aditya Puri (ex-CEO, HDFC Bank) said that HDFC Bank would become larger than Muthoot Finance. Today, the gold loan book of HDFC Bank is just Rs 10,000 crores, and Muthoot Finance is at Rs 60,000 crores. Goes to show how tough it is for even the best-managed private sector banks to succeed in this space. And in bad times, if you have to grow, the work is even harder.

But banks again re-entered this space, isn’t that why the gold loan stocks took a beating? Why the change in approach again?

Post-COVID, there was an environment of risk aversion. Nobody was doing personal loans, microloans, or business loans. So, gold was the most logical thing to do and many banks jumped in. They started poaching employees from NBFCs; the NBFC employees started calling their customers and saying, “If you have a loan at 18 percent, I can give you one at 12 percent”.

Initially, banks got a big bump up in volumes. But then, gold is a branch-driven business. Like, if a branch does not do more than Rs 15 crore of gold loans, it will not break even. Profits in the first year were good because the growth was there. In the second year when the growth slowed down, they realized, “Oh, we are giving so much effort, but where is the profit?” In the third year, a lot of people will say “Hey, it's not working out. Let's close it.” I think we are already in the third year and we will see a lot of banks throwing in the towel.

How does that place gold loan NBFCs like Manappuram and Muthoot?

Obviously, banks cutting back (on gold loans) is good news for these companies. But we are not going to go back to the old days when Muthoot and Manappuram were the only gold loan companies; there will be many more companies. But there is a case for Muthoot and Manappuram also to do well. Having said that, it's not possible to grow beyond 10-12 percent in gold. In India, if you can’t show 15 percent growth, the market does not give you great multiples. So, Muthoot and Manappuram will have to look beyond gold loans to boost that growth rate from 10 percent to 15-16 percent. Only then will the market re-rate these stocks.

What is your outlook on Manappuram?

Manappuram was purely a gold loan company until 2016. Then it acquired a company called Ashirwad Microfinance. At the same time, they started commercial vehicle loans and got into the home loan business as well. Today, 60 percent of the loans are in the gold segment, and 40 percent are from all the other new areas. Ideally speaking, this is a story that the market wants to hear: that someone has diversified from a single product to a multi-product organisation. But the ground reality is a bit different.

The promoters did not understand the microfinance business well. They appointed an outsider, who tried to grow the business in a rush, and it resulted in losses, with COVID aggravating the problem. Even in the vehicle finance business, the company reported deep reported deep losses. We had been to one of the dealerships, and we saw that the least creditworthy customers and worst vehicles were being financed by Manappuram because the dealer was passing on the best customers to the bigger names in that space. So the market is concerned that the new businesses are not working out well so far. While Manappuram is a diversified company today, 90 percent of the profits still come from gold.

What about Muthoot Finance?

Muthoot, I would say, is a more conservative company. They also diversified, but they went about it slowly. They diversified in the same year when Manappuram started diversifying. But even today, only 10 percent of Muthoot's loan book comes from microfinance, commercial vehicle finance, and home finance; 90 percent still comes from gold because they also internally knew that okay, we are not the champions of non-gold businesses. So, they took slow baby steps. I think their baby steps in microloans are slightly successful, maybe they'll push the pedal there. We like the approach more because when you enter completely new businesses, you should go slow because in the lending business initially, your employees themselves will commit fraud and fleece you.

So Muthoot is going slow. It has a customer base of roughly three crore customers; like, two crore customers walk into their branches every year, so it's a huge scale of operations. So what they're trying to do is they're trying to tell these customers, “Hey, do you want a two lakh rupee LAP loan?” So if they can actually do that, the rundown of the book will actually reduce because an LAP loan is a seven-year loan and a gold loan is a seven-month or six-month loan. If it succeeds in these microloans, LAP loans, I think you will see a second round of rerating, compounding and all that.