The RBI has come up with norms to curb the formation of a bubble in the gold loan segment and prevent a repeat of the infamous MFI story, says Nirmal Bang's research report.
If you were banking on your gold jewellery to get a loan, be prepared to pledge more gold to obtain that loan. In order to curb the rampant growth of gold loans that had become a norm over the past year or so, the Reserve Bank of India recently told Non Banking Financial Companies (NBFCs) to give a loan of 60% of the value of gold (technically called the loan to value ratio) that is presented to the loan seeker.
Getting RealisticThis essentially means that if the value of gold that you are pledging is `10,000, you will get a loan of Rs 6,000 on it. Earlier, NBFCs used to lend 90% to 95% of the value of gold that was being pledged. RBI data shows that banks and NBFCs together were doling out as many as 1,20,000 new gold loans in a day.
The RBI has also barred such NBFCs from giving out advances against gold or gold coins. NBFCs whose gold loans comprise more than 50% of their assets, should mandatorily maintain Tier II capital of 12% as stipulated by the RBI. NBFCs have been given a deadline of April ’14 to comply with this norm. Also, in order to encourage transparency and to keep a tab on their operations, the RBI has now mandated NBFCs to disclose the percentage of gold loans to their total financial assets.
Indians’ love for gold is legendary to say the least. Ballpark figures suggest that Indians privately own 18,000 tonnes of gold in physical form. Looking at this great untapped opportunity, a couple of NBFCs jumped into the fray and started doling out gold loans to retail investors. Not to be outdone, banks too joined the bandwagon soon after. The result? The gold loan business grew in leaps and bounds over the last few years especially when the financial markets were in a turmoil.
Traditionally, people turn to gold as a safe haven when the markets are uncertain. Moreover, as 2011 was a particularly bad year following the start of the debt crisis in the Euro Zone, the value of gold appreciated manifold. With borrowers realizing that they could get more money by pledging the same amount of gold, the business of gold loans rose swiftly. In 2011, gold loans worth `80,000 crore were given out to consumers. The business of gold loans was growing at an average rate of 70% for NBFCs and 35% for banks.
What was particularly alarming was the rise of Mannapuram Finance and Muthoot Finance. These two NBFCs had grown like the proverbial beanstalk and had registered a growth of 170% and 96%, respectively. It was not long before that the credit rating agencies had started sounding off the alarm bells.
Vulnerable NBFCsCredit rating agency, ICRA in a report on gold loans, stated that if gold prices were to fall in 2012, by anything close to the margin that they had risen in 2011, there would be a significant systemic risk in the financial system. This is because NBFCs themselves are huge borrowers and, therefore, susceptible to much larger risks than banks. Also, with the RBI having said in the year 2010 that NBFCs will no longer be considered as priority sector lending, banks had already pruned their exposure to NBFCs.
But this did not have an impact on NBFCs giving out gold loans. Making the most of the sorry state of the microfinance industry, the NBFCs were having a dream run. And with borrowers opting for more gold loans in times of crisis, the average ticket size of gold loans was being pushed higher by lenders such as Muthoot and Mannapuram.
While there is no harm in growing the business, what RBI is worried about is the possible downside if the prices of gold start falling suddenly. Although worldwide bullion analysts are reassuring that gold as of now is the only safe haven that investors can turn to, short-term blips cannot be prevented if investors choose to sell some gold to book profits . If such a thing does happen, gold prices will drop and gold loans in India will be impacted negatively. This is because gold loans are short-term (with tenure of three to six months). Short-term loans have higher risk as compared to long-term loans as people start defaulting on short-term loans first when crisis strikes.
A Bubble in the MakingThere are several other reasons that the RBI may have considered before proactively curbing down the business of gold loans. Firstly, bearing an uncanny resemblance to the MFI story, the gold loan story is way too concentrated in the southern part of India. Though nothing like MFIs is likely to happen in the gold loan industry, the idea of concentration in one geographic location is a cause of concern.
Secondly, the competition in the gold loan space was getting intense. When gold lenders started out, they were essentially competing with money lenders. As a result, interest rates were high and margins were lucrative. Looking at the almost instant formula for success, anybody who had a footprint in the financial domain wanted to get into gold loans.
But this kind of heady growth would have ultimately spelt doom for the industry. Excess competition would thin down margins and increase risks for lenders. This is especially true for private companies such as Muthoot and Mannapuram who had to borrow from the market at a higher cost in an attempt to fund their loan books. Muthoot Finance recently raised a non convertible debenture at 12.25%. The RBI clearly does not want a repeat of the MFI fiasco that took place in Andhra Pradesh, and, hence, is taking proactive measures to put an end to the giddy pace of growth in the gold loans segment.
The fact that it has hit the nail on the head is evident. The stocks of both
Muthoot and
Manappuram are taking a beating on the bourses. Though the outlook on gold remains bullish for the long-term, this sure seems to be an attempt on part of the RBI to stomp out a bubble in the making.
Source: Nirmal Bang's Beyond MarketClick here to read the full magazineDisclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions. 
