Gold loan market jumps 122% as gold prices continue to hit all-time highs; Know hidden risks

Shaji Varghese, CEO of Muthoot FinCorp Ltd, says, “Central banks across the world are now major gold purchasers as part of their risk diversification strategy." Varghese adds that "consumer demand" remains strong, where gold holds cultural significance beyond economic value.

These trends have made gold an appealing asset, with price appreciation creating ripple effects in the loan market by increasing the value of pledged collateral.

Demand patterns and borrower accessibility

The demand for gold loans in India has surged sharply in recent times, driven by multiple factors. A key catalyst is rising global uncertainty, which has kicked gold prices higher. As a result, gold’s attractiveness as both an investment asset and borrowing collateral has increased significantly.

Another factor contributing to this surge is the tightening of unsecured loan options. Post-pandemic, unsecured loans such as personal loans and credit cards ballooned rapidly. In response, the Reserve Bank of India (RBI) raised risk weights on unsecured personal loans in late 2023, forcing banks and non-banking financial companies (NBFCs) to hold more capital against this credit. This regulatory change increased the cost and restricted the availability of unsecured loans, nudging borrowers toward the safer, gold-backed credit segment.

Traditionally viewed as a tool of last resort, gold loans today are shedding this stigma. According to experts, gold loans are increasingly used by urban millennials and semi-urban borrowers as a convenient and trendy way to fund aspirations, be it a wedding, a business, or education.

Moreover, demand for gold loans peaks during festive and monsoon seasons, driven by business and personal needs. Jadhav explains that "small traders typically take gold loans to stock goods for festive seasons," with borrowers including "farmers, small traders, households, and entrepreneurs." He notes consistent growth at "30-40 percent CAGR annually," emphasizing that loans are used for working capital, especially during high-demand periods like festivals."

A key advantage is accessibility for those with poor or no credit history as it’s a secured loan against the pledged gold. RBI is allowing up to 85 percent loan margin for small borrowers (i.e. for loans under Rs 2.5 lakh, including interest)."

Varghese says, "past credit history is not a mandatory requirement," making gold loans ideal for individuals with low credit scores re-enter the formal lending system.

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Navigating price fluctuations

Rising gold prices often lead to top-up loans. Jadhav says, "Borrowers take additional loans if gold prices rise, with increased demand from small traders and farmers." When prices dip, lenders monitor margins daily; borrowers must "add more ornaments to adjust margin" or "repay part of the loan amount," he adds.

Varghese notes that higher prices allow borrowers to potentially take larger loans, but dips require maintaining the loan-to-value (LTV) ratio by repaying or adding security, with alerts via SMS alerts and calls.

Revised RBI guidelines as announced in June

The banking regulator has prohibited banks and financial institutions from granting loans against gold bars (bullion) or financial assets backed by primary gold or silver, e.g., units of exchange-traded funds (ETFs) or units of mutual funds and digital gold.

This move aims to regulate the gold loan market and mitigate potential risks associated with lending against certain gold-backed financial instruments.

RBI's move is more of a reinforcement of existing rules rather than a new restriction. “The RBI broadened the scope to include silver as an eligible security, while continuing to exclude gold ETFs and similar financial instruments as collateral,” says Varghese. Overall, he doesn't foresee significant disruption to existing lending practices, as this move largely clarifies and reaffirms current norms alongside harmonising the guidelines across the REs (regulated entities).

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Benefits and risks in gold loans

While benefits include quick processing, flexible repayments, and accessibility for low-credit borrowers.

Interest is calculated on a "daily diminishing balance method," says Varghese, affected by tenure and LTV. Jadhav adds it's influenced by "loan margin" and "credit profile," typically lower than unsecured loans.

Drawbacks include, risk of gold loss and higher rates for high-risk borrowers, price dips can breach loan-to-value ratios, forcing borrowers to repay partially or pledge more gold, risking auction and loss of ancestral jewelry.

Auction of pledged gold takes place as a last resort after 40-60 days of follow-up on non-payment of the loan amount.

While gold loans have become more accessible with banks and fintech companies offering quick solutions, do understand the risks involved if you fail to make the timely repayment.