Over the last decade, the rise of NBFCs that focus on gold loans has been well-chronicled by the media. They are now widely acknowledged as being instrumental in formalising an activity hitherto the preserve of shadowy moneylenders and pawnbrokers operating away from regulatory oversight. Banks were largely uninterested in gold loans, giving a free run to the unorganised players until their dominance was challenged by gold loan NBFCs. But these days, we see the private and public sector banks make a vigorous play for gold loans.

According to the RBI’s latest monthly data on sectoral deployment of bank credit, the gold loans portfolio of banks stood at ₹62,926 crore as of August 27, 2021. Compared to ₹37,860 crore a year ago, that is a jump of 66 per cent in one year. Go further back and, in August 2019, it stood at just ₹26,542 crore. Clearly, banks in India are now a rising force in the gold loan space.

Favourable treatment

What explains the spectacular growth in the gold loans portfolio of the banking sector over the last one year? There’s no doubt that favourable treatment by the regulators was an important factor.

Early in August 2020, the RBI had announced an increase in the loan-to-value ratio on gold loans given by banks (from 75 per cent to 90 per cent) up to March 31, 2021, to provide relief to borrowers affected by the pandemic. That relaxation was not extended to NBFCs, and it opened up a limited-time window of competitive advantage for banks that was duly exploited by them.

Another reason was that sporadic lockdowns had a milder impact on the organised sector, whose digital reach and capabilities are much greater. Corporate India, for instance, reported higher-than-expected profits in the lockdown-affected quarters even without gain in volumes, thanks largely to the cost cutting enabled by their digital reach.

Oganised sector

Banks deal predominantly with customers from the organised sector, who were relatively less impacted, but nevertheless found access to regular loans harder to come by. On the other hand, the unorganised sector bore the pain much more and for an extended period. Lacking scale and a digital backing, many were forced to shut shop. A significant section of borrowers of the gold loan NBFCs belong to this segment, and the uptake of gold loans was affected.

A lesson to learn

One of the key learnings from the pandemic and its aftermath is that in periods of acute economic distress, the wider financial services sector (banks and non-banks alike) is also put to severe stress. The consequence is that lending activity slows down drastically as the appetite for risk and disbursing new loans falls.

With risk aversion running high, often the only loan available in the market to the masses was gold loans. Earlier, this would have meant approaching a specialised gold loanNBFC or a pawnbroker. These days banks have also upped their gold loan game.

Besides, as a strategy, increasing your lending against a liquid collateral that preserves its value during economic distress is a no-brainer. At the same time, a word of caution is in order. About a decade ago, many banks and NBFCs had forayed into gold loans, lured by the example of gold loan-focussed NBFCs whose business had boomed in the preceding half decade.

The crash in gold prices in 2013 was a rude wake-up call. Most of these new entrants took the exit route as fast as they had come in. The need to set up robust risk management processes before taking the plunge was now clear. An essential component of risk management in gold loans is the auction policy. It matters a lot, especially in a scenario of volatile gold prices. Among the unbanked, gold is not so much an investment as much as an avenue to park one’s savings in. After the harvest, when small farmers end up with surplus money on their hands, they often buy gold as they lack access to banks.

Later, in the sowing season, when they need money the most, they may either sell the gold or pledge it to draw cash.

This is how things have been going on for ages. And sometimes, it can happen that financial adversity leaves the borrower no choice but to let go of his gold, and this is also part of the game. In recent days, gold loans going into auction have become a subject of animated discussion in the media as part of the wider narrative about distress in the economy.

While the suffering is real and undeniably a factor responsible for higher auctions, the impact was also aggravated by the price of gold, which has corrected sharply from the all-time highs of August 2020. In the seven months up to March 2021, gold price fell by over 20 per cent; a fall of this magnitude was last seen in 2013. The unexpected confluence of a raging pandemic and a sudden crash in gold price fed into higher auctions.

An unhappy experience

Since losing one’s gold is an unhappy experience for all, industry players have given much thought to how this may be minimised. One of the changes that has come about is the insistence by lenders on periodic payments of accrued interest.

Traditionally, the gold loan product carried a tenor of one year and bullet repayments of both principal and interest was the norm. But now, with periodic interest payment, the compounding burden on the borrower is lessened. A few have gone further.

For instance, at Manappuram Finance, we opted for a short-term gold loan product as the best way to manage the gold price risk. It offers benefits both to the borrower and to the lender. The lending firm can manage the price risk and asset quality prudently without taking away flexibility from customers in respect of their credit requirements. Customers can renew the loans indefinitely by periodically settling the interest and resetting the principal to the prevailing gold price. This avoids the risk of a compounding interest piling up over the course of the year.

However, we must acknowledge that the gold loan sector cannot hope to be fully immune to the vagaries of the wider economy.

(The writer is the MD & CEO of Manappuram Finance.

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