ICRA Research has come out with its report on Rao Committee.
The KUB Rao committee report on gold loan companies (GLCs), released by the Reserve Bank of India (RBI) on January 2, 2013, recognises the need for strengthening the GLCs’ processes, improving their transparency, and rationalising the interest rates offered by them. At the same time, the committee acknowledges the positive role of banks and non-banking financial companies (NBFCs) in monetising gold. The acceptance of “gold loan product” by the committee (and possibly by the RBI) and the proposed steps to enhance discipline and transparency could improve the confidence of institutional investors in GLCs, which in turn could help them mobilise institutional funds (in tight supply since March 2012) and use that for future growth. Further standardisation in the valuation of gold, improvement in grievance redress and documentation, and auctioning could bring in greater transparency and discipline among GLCs. While standardisation of gold valuation at the current 60% loan-to-value (LTV) may have constrained the growth of NBFCs, the proposal to raise the LTV ceiling to 75% could give GLCs flexibility to grow their business at a reasonable pace. The RBI has sought the comments on the KUB Rao committee’s report by January 18, 2013, following which it may introduce some changes in the regulations. Overall, the RBI’s guidelines on LTV, lending rates and on retail non-convertible debentures (NCDs) would have a significant bearing on the growth prospects and profitability of GLCs. ICRA’s assessment of the likely impact of the committee’s recommendations on the gold loanmarket is as follows:- Standardisation of valuation of gold and increase in the LTV cap from 60% to 75% would help GLCs increase business volumes at a reasonable pace, although the pace of growth is likely to be much lower than the over 120% compounded annual growth rate (CAGR) witnessed over the last three years.
- As banks enjoy a competitive advantage over NBFCs, and given the healthy risk-adjusted returns and growth prospects in the gold loan segment, banks could step up the pace of growth of gold loans. Were this to happen, the market share of NBFCs in gold loans may not increase from the current 28% (as onMarch 31, 2012)
- Constraints of institutional funding could ease for NBFCs as the policy direction becomes clearer, but some NBFCs may need to reduce their reliance on retail NCDs, which in turn would impact their growth in the short term.
- Significant funding constraints (despite possible easing) may slow down the pace of growth of GLCs, as such entities are highly reliant on wholesale funding sources. However banks, which dominate the market with around 72% market share, could expand the Rs. 1.4 trillion gold loan market significantly in the short term and also increase their market share; the growth could however be lower than the 70% CAGR witnessed in the last three years.
- The committee has recommended rationalisation of interest rates charged by NBFCs by linking the same to the maximum advance rate of State Bank of India (SBI). However, it has not clarified what the spread over/under SBI’s maximum advance rate should be, or what should be taken as SBI’s maximum advance rate. Capping of interest rate without reference to the borrowing costs of the underlying NBFC would be a negative, given the dynamic nature of funding costs. A more appropriate approach would be to impose a cap on the lending margins, as has been the case in the microfinance segment, where the same has been capped at 10%. A lending yield cap of 8-10% over SBI’s base rate and increase in Tier I to 13% (as GLCs have to maintain Tier I of 12% by April 1, 2014) could lead to a drop in the return on equity (ROE) to 8-19% from the current 30%.
- The restriction on opening of braches beyond 1,000 a year may lead to a gradual build-up of branch network and could help in better risk management at the GLC level.
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