Gold loan risks: RBI exposes irregularities, borrowers beware

On September 30, the Reserve Bank of India (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, popularly known as gold loans.

These irregularities include shortcomings in using third-party agencies for sourcing and appraising loans, valuing gold without the customer being present and inadequate due diligence.

The deficiencies also include lack of transparency during auction of gold ornaments and jewellery on default by the customer, weaknesses in monitoring of loan-to-value (LTV), incorrect application of risk weights, know your customer (KYC) compliance  done through fintechs rather than in-person verification and loans rolled over at the end of their tenor with only partial payment.

The central bank found this after carrying out a review of levels of adherence to prudential guidelines as well as practices being followed by SEs with regard to loans against pledged gold ornaments and jewellery.

Growth of gold loan segment

Rising gold prices have led to an increase in the size and number of gold loans. Customers with higher gold holdings are also monetising their jewellery. Due to greater awareness, many customers today consider a gold loan a personal finance product.

According to a study by credit rating agency ICRA, the overall organised gold loan segment has expanded at a compound annual growth rate (CAGR) of 25 percent over FY20-FY24, driven by banks, which expanded these loans at a higher CAGR of 26 percent, while non-banking financial companies (NBFCs) expanded theirs at 18 percent during the same period.

Public sector banks (PSBs) accounted for about 63 percent of the overall gold loans in March 2024, up from 54 percent in March 2019, while NBFC and private banks’ shares moderated by an equal measure during this period.

Precautions borrowers need to take

• Research and verification

Taking out a gold loan requires awareness and  care to avoid potential pitfalls. To ensure a secure experience, it's crucial to properly study the loans on offer, comparing interest rates and charges from various RBI-approved lenders. This helps identify the option best suited to your needs.

• Understand loan terms

“When reviewing gold loan offers, carefully examine the fine print, paying attention to interest rates, fees, loan tenure, repayment options and the LTV ratio, which should align with the RBI's 75 percent limit,” Shripad Jadhav, president, retail agriculture and gold loans, Kotak Mahindra Bank, said in an interview with Moneycontrol.

• Know gold valuation and auction processAdditionally, understand the lender's gold valuation methodology and auction process in case of default.
• Beware of red flags

Be cautious of unsolicited offers from banks, NBFCs and fintech lenders, which may come with hidden terms. “Red flags to watch out for are unusually jumping interest rates, lack of transparency in charges and repayment structure,” said Sharad Ingule, founder and former CEO, GoldUno, an online gold loans provider. The jumping rate in gold loans refers to a scenario where the interest rate charged on the loan increases after missing the payment due date or upon certain conditions.

• Essential safeguards to put in place

To protect your interests, take the following measures—take a good look at the lender’s reputation before taking a gold loan; ask questions on the gold loan offer and clarify any and all doubts; ensure clear loan documentation; and review loan terms carefully.

By exercising due diligence and awareness, you can make informed decisions, avoid potential pitfalls, and safeguard your gold collateral.

Lenders given three months to review policies

The RBI has advised all SEs to review their policies and practices related to gold loans and take corrective measures within three months. Non-compliance with regulatory guidelines will be taken seriously and may attract supervisory action from the central bank.