India is known to possess large stocks of gold, estimated at about 11 percent of global gold stock. Over the past ten years, the value of gold in India has increased at a compounded average growth rate (CAGR) of 13 percent, outpacing the country's real gross domestic product, inflation and population growth by 6 percent, 8 percent and 12 percent respectively. India has one of the highest savings rates in the world (34 percent of GDP in FY10), of which one third is invested in gold 1.
In India, gold prices increased by a staggering 180 percent during FY06-FY11 and have outperformed practically all known asset classes in the last decade 2 It is estimated that 10 per cent of the country’s gold stock is pledged as collateral for loans, of which approximately 75 percent is in the unorganized market (money lenders, pawn brokers, etc.), and the remaining 25 percent in the organized market (specialized Non-Banking Finance Companies (NBFCs), other NBFCs, commercial/cooperative banks, etc).3 The value of the organized gold loan market in India is estimated at INR 400-450 billion, with a CAGR of approximately 40 percent during FY02-FY10.4
Gold loan NBFCs have recorded significant growth in recent years in terms of both their balance sheet and physical presence. These NBFCs have increased their books by a little more than 50 percent year-on-year over the past two years, while banks registered growth of only 32-37 percent.5 To meet their growth objectives, the NBFCs have increased their dependence on public funds, including bank finance and non-convertible debentures issued to retail investors.6
With these NBFCs are growing beyond the normal rate, the impact on them of any future crash in price by the same margin or more could be severe. The financial sector may also be affected, since NBFCs are often big borrowers. To rein in the uncontrolled growth of gold loans and reduce the risks involved (concentration risk and market risk because of adverse movements in gold prices), the Reserve Bank of India (RBI) has brought in a slew of measures to tighten regulatory supervision in the sector during the last year.
Earlier, in February 2011, the RBI removed priority sector status from gold loan companies, which led to a higher cost of borrowings for these companies.7 In another step to protect the financial system against any possible adverse movement in gold prices, RBI introduced the following guidelines for gold loan NBFCs in March 2012:
- Loan to value (LTV) ratio not to exceed 60 percent for loans granted against the collateral of gold jewellery
- Percentage of gold loans to total assets to be disclosed in balance sheets
- Loans not to be granted against bullion, primary gold, gold coins
- Tier I capital requirement (currently 10 percent) raised to 12 percent by April 1, 2014 for gold loan NBFCs (where such loans comprise 50 percent or more of their financial assets).
As there were previously no LTV restrictions, many companies had extended up to 90-95 percent of the value of gold jewellery as loans, and a relatively small proportion of the lending happened at LTVs of 60 percent or lower.8 The new LTV cap of 60 percent could result in significantly lower growth rates, as borrowers will have to bring in additional gold jewellery to obtain a loan of the same amount. The RBI’s new measures could also adversely impact the asset quality of gold loan companies in the short term as the loan eligibility of borrowers seeking refinance is expected to decline. In addition, this development could result in business shifting to the unorganized sector or to banks, which would continue to extend loans at higher LTV ratios. The current high profitability of gold loan companies may also moderate as they are likely to reduce pricing in order to protect their market shares and prevent a shift to the unorganized sector.
The RBI guidelines are expected to impact gold loan NBFCs’ business in the short-term. Business growth could fall from more than 50 percent to 20-25 percent per annum while return on assets could fall from 4.5 percent to 2.5-3 percent.9 However, in the long term these guidelines should have an overall positive impact on the sector, by bringing regulatory clarity. The moderation of growth would increase the confidence of stakeholders, including banks and other investors, in the sector. In addition, the LTV cap would lead to better asset quality. Furthermore, slower growth rates will likely reduce capital requirements over the medium term.
In April 2012, the RBI required banks to reduce exposure to any single NBFC engaged in the gold loan business from the current 10 percent of their capital funds to 7.5 percent.10 This means that banks will have fewer funds to lend to these gold loan NBFCs, which will increase their borrowing cost. Even if the new regulations attempt to make gold loan NBFCs less attractive, these specialized NBFCs have nevertheless created a niche for their gold loans capabilities by flexibility, easy access, low levels of documentation and formalities, quick approval and disbursal of loans, faster turnaround time, customer trust, ability to service non bankable customers and quality of service. These unspoken associated benefits will help NBFCs to capture and sustain a significant portion of the gold loan market share in future, in spite of the tighter regulations.
To summarize, these guidelines might moderate the growth and impact the profitability of gold loan NBFCs in short term. In the long term, however, they are expected to enhance the gold loan NBFCs’ ability to assimilate the impact of any sharp decline in gold prices, thereby improving the sector's asset quality. These guidelines should not only strengthen the well-capitalized established business players but also help regulate new players which lack the experience or the necessary understanding of the business, making the gold loan market more mature.
1. World Gold Council, Reserve Bank of India, 2010
2. Reserve Bank of India, Handbook of Statistics on Indian Economy, 2010-11
3. IIFL ‘Gold Loans – Lending with Comfort’, June 2011
4. ICRA Press Release, 22 March 2012
5. ICRA Press Release, 22 March 2012; Business Standard, 18 April 2012
6. Reserve Bank of India, Lending Against Security of Single Product – Gold Jewellery, 21
March 2012
7. Business Standard, 18 April 2012
8. Finance Express, 22 March 2012
9. Crisil Press Release, 22 March 2012
10. Reserve Bank of India, Monetary Policy Statement 2012-13