Vault matters | Barely discussed concerns in gold loans

A fast growing trend of lenders opting to swap their unsecured loans with secured products, largely gold loans.

The year gone by has been a period of reset for lenders in the gold loan segment, whether banks, non-banks or even fintechs. When the Reserve Bank of India placed IIFL Finance under curbs in March this year, it attempted to set right the industry in some sense.

The circular issued months later was aimed at correcting some of the operational irregularities in the system which by now have become the norm. Alongside this correction in the industry is the newly initiated but fast growing trend of lenders opting to swap their unsecured loans with secured products, largely gold loans. On a year-to-date basis in FY25, outstanding gold loans has risen by 50 percent to cross the Rs 1.5 lakh crore threshold. On the face of it, the pivoting from unsecured to secured gold loan business seems to be a foolproof idea. But like always, the devil lies in the details.

Pivot to gold loans comes with higher costs

By virtue of the product outlay, gold loan business, which involves a layer of due diligence, storage cost, cost of preserving the underlying pledged asset and the cost of auctioning, is more expensive compared to an unsecured business. Perhaps for this reason, lenders who over a short time migrated from unsecured products to gold loans, in order to maintain their profitability, haven’t tinkered much with the rate of interest they charge. They don’t have much bandwidth to go easy on rates as it might impair their financials in unthinkable ways.

Secondly, this is a segment where borrowers invariably come back to the lender for a rollover in loan. It is too soon to say that lenders are compliant with norms on loan-to value as concerns around this would show up only after a year of rolling over the loans. With gold prices not moving much this year, relatively stable gold prices and a steady increase in loan-to-value as rollovers gather pace is a sure shot recipe for disaster; one that the microfinance industry is now going through.

End-use of gold loans impinges on associated risk

The last aspect should be more concerning – that of end use. Personal loans are akin to working capital loans for retail borrowers. Gold loans on the other hand, is either to meet some temporary requirements in the business or emergencies in the family. In other words, gold loans are meant to be extended for income-generation purposes, whereas, personal loans are consumption oriented.

If the purpose of gold loans is swapped from income generation to consumption, that’s a sure shot for failure. Especially, at times when delinquencies increase. It’s a layer above the bottom of pyramid to mid-income group currently targeted by lenders. This is also the segment vulnerable for socio-economic crisis, often adversely impacting the lenders when the tide turns low.

Right now, the secured lending space, especially gold loans are engulfed by a wave of over-optimism. These concerns don’t seem to be taken into account. But is the regulator seeing through the microscope? Hope we don’t stare at another crisis three years from now similar to the ongoing one in the microfinance space.