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Consumers Rely On Gold Loan To Beat Credit Crunch

Author: Dasari Sreenivasa Rao/Wednesday, November 18, 2020/Categories: Exclusive

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Consumers Rely On Gold Loan To Beat Credit Crunch

In last decade, return on gold (10.14%) outperformed BSE Sensex (8.11%) and 10-year government bonds (9.12%); Outstanding gold loans at NBFCs rose from Rs 115.3bn ($2.43bn) in FY-10 to Rs 760bn ($10.4bn) in FY-20 at CAGR of 20.8, says WGC

Gold occupies a vital place in the hearts and homes of Indian consumers and is often considered as a symbol of social status, financial security, and cultural legacy. Households in India are emotionally attached to gold jewellery and prefer to use gold as collateral to meet their financing needs rather than outright selling. For generations, all sections of the society have used gold as a means of financing, often pledging it as collateral to raise funds to plant the following year’s crops. Pledging gold as collateral to meet financing needs has been an ever-present feature of the Indian gold market. Indian households generally depend upon gold loans to meet the financing requirements for health, education and marriage, while small business firms and family business entities use them for their working capital requirements. 

Demand for gold loans, both through banks and non-banking financial company (NBFC) has been growing in the times of Covid-19, which took a toll on the Indian economy. As a result, outstanding organised gold loan is expected to grow to Rs4,051bn ($55.2bn) in FY 2021 from Rs3,448bn ($47bn) in FY 2020, according to a latest study by World Gold Council (WGC).

Non-banking Finance Companies (NBFCs) are playing a vital role in domestic gold loan market. With the advent of technology applications, NBFCs have become game changer in gold loan market.

Gold loans are popular in both urban and rural areas. They compare favourably with personal loans regarding quicker processing time, no requirement of income proof or prior credit history, and low processing fees. With such advantages, the overall gold loan market has grown from Rs600bn ($12.6bn) in FY 2009-10 to Rs9,000bn ($122.6bn) in FY 2019-20, a compound annual growth rate (CAGR) of 31.1 per cent over the last decade. Organised and unorganised gold loan market gold loan market in India can be categorised as organised gold loan market includes banks (private, public co-operatives and small finance), non-banking financial company (NBFCs) and Nidhi companies.

“The gold loan industry has traditionally been a pillar of support for small businesses and households in need of emergency short term assistance,” observes Somasundaram PR, managing director, World Gold Council (India).

Unorganised gold loan market includes pawnbrokers and money lenders. The origins of informal gold lending can be traced back to traditional money lenders such as the Chettiars of Tamilnadu and landowners in India who provided loans against the jewellery held by villagers. Unorganised gold loan market still accounts for 65 per cent of the gold loan market, but organised gold loan market has grown with the market penetration and geographical expansion of financial service institutions and financial inclusion. 

“In addition to unorganized lending that normally co-exists with any robust gold market, the regulated Institutional framework of gold loans in India has made it ubiquitous over the past decade which is indeed a boon. In particular, Covid-19 has boosted demand for gold loans through banks and non-banking financial companies. The recent rise was seen some time since July 2019, when prices started moving up sharply. A 28.8 per cent rally in domestic gold price this year and the need for quick credit among small businesses will further spur gold loans’ growth post Covid-19. Gold loans will benefit not just from the demand side but supply side dynamics too as many banks and non-banking institutions target this product segment on account of its acceptable risk profile,” said Somasundaram.

Banks primarily offered loans to gold loan NBFCs to meet their requirements for priority sector lending (PSL), such as agriculture and allied services. But this changed in February 2011, when RBI removed the lending of banks to gold loan NBFCs from priority sector lending. Banks have played a key role in the growth of organised gold loan market, but have lacked the turnaround time to disburse gold loan and flexibility of non-banking financial company (NBFC).

Somasundaram further elaborated that “India’s leading gold NBFCs expect their gold loan AUMs to grow by 15-20 per cent in the current financial year.  Further, branch expansions of gold loan NBFCs and increased adoption of technology makes the growth outlook of the gold loan market look even more promising. The market is expected to grow at an annual rate of 15.7 per cent and reach Rs4,617bn in FY 2022 from Rs3,448bn in FY 2020. This report outlines the growth story of gold loan market in India, its regulatory landscape and highlights key trends during Covid-19 with pointers to how technology has enabled greater reach and adoption. It discusses how digital offerings in the form of online gold loan (OGL) scheme have seen good traction since their inception. It also shares recommendations on what more can be done to increase penetration of financial inclusion through the gold loan industry. All in all, a good read in the current context.”

Today, gold loans are used to meet the expenditures for health, business, education, and marriage. The evolution of the gold loan market began in southern India, in the state of Kerala. Leading Kerala-based gold loan companies, Muthoot Finance and Manappuram Finance, can trace their origins back to 1939 and 1949, respectively. Another Kerala-based gold loan company, Muthoot Fincorp, ventured into the gold loan business in the 1950s. Before this time, the gold loan market was mostly informal (loan disbursed by money lenders and pawn brokers), but it started to change after the entrance of banks in the 1960s. The formalisation of the gold loan market gained further momentum when the Reserve Bank of India (RBI) granted a license to Manappuraam Finance and Muthoot Finance to work as a NBFC in 1998 and 2001 respectively. 

Gold loan Cos Propelling Growth

Gold loan NBFCs have gained competitive strength in their fast gold loan processing and auctioning off gold jewellery which has not been reclaimed by consumers. Gold jewellery kept as a collateral against gold loan by top three gold loan NBFCs (Muthoot Finance, Muthoot Fincorp and Manappuram Finance) totalled 298.8t at end of FY 2019-20. According to the WGC report, the combined gold holdings of these three NBFCs would rank in the top-20 gold reserves of central banks and supranational organisations (i.e. IMF, ECB, BIS). Together with the gold jewellery kept as collateral, the outstanding gold loan NBFCs value have increased exponentially in last decade from just Rs 115.3bn ($2.43bn) in FY 2009-10 to Rs 760bn ($10.4bn) in FY 2019-20 at CAGR of impressive 20.8 per cent. While gold loan NBFCs have indeed shown accelerated growth, banks’ share of market is has remained above 70 per cent since FY 2013-14 due to lower stress in gold loan portfolio for banks due to their diversified loan portfolio as compared to gold loan NBFCs. In early August the RBI increased the LTV ratio to 90% from 75% until 31 March 31 2021.

This potentially could further increase the demand for gold loan through banks. In case of sharp decline in gold price, banks ask consumers for part-prepayment or additional collateral to bring the LTV to the desirable level. Banks also adopt lower of either last month moving average or current gold price for gold valuation for short-term fluctuations in gold price. With these measures, banks control any increase in their credit risk for gold loans in case of a sharp decline in gold price and grow their gold loan share, says WGC. Digitalisation of economy and e-commerce penetration are fundamentally altering the age-old scenario, so an element of option beyond gold and real estate in asset portfolio is setting in – though this may take time and may need some catalyst to show tangible results. As of now, love for gold and a window to accumulate wealth without much of the disclosure that financial assets ensue, keep gold central in rural wealth. In the last decade, the return on gold (10.14%) has outperformed the BSE SENSEX (8.11%) and 10-year government bonds (9.12%) – supporting gold’s appeal as an investment.

Financial inclusion

Gold is a prominent feature in India’s investment landscape. Our market research indicates that as of Q3, 2019, 52 per cent of investors already owned some form of gold, with 48 per cent having invested in the 12 months preceding Q3 2019. The average Indian household holds 84 per cent of its wealth in real estate and other physical goods, 11 per cent in old and rest five per cent in financial assets. Dependence of rural households in physical assets such as gold has been a result of not just love of gold, but also poor banking penetration till lately, when a government scheme- Pradhan Mantri Jan Dhan Yojana (PMJDY) launched in August 2014 altered the scenario by covering every households with a bank account within six years of the launch of the scheme. The expenditure on gold has steadily increased over the years both in urban and rural households’ budgets driven by a rising gold price and affinity towards gold both as an adornment and investment. Jewellery still eludes wealth disclosures of the type that financial assets require and that remains a support factor.

Monetising gold in India

Gold remains a preferred investment for Indian retail investors, just behind life insurance and savings. WGC in its report elaborated that Indians have invested and saved in gold for decades, and total holdings of gold in India are estimated at around 25,000t, valued at $1.45 trillion. In the late 1990s, the Indian government attempted to monetise the significant gold stock by introducing the Gold Deposit Scheme (GDS) in September 1999. This allowed consumers to deposit physical gold in banks, earning interest in return. The scheme struggled for success due to the sizable minimum deposit of 500 grams of gold which acted as a huge deterrent for consumers. 

A revamped GDS scheme was launched during the Union Budget of 2015 with a new name of Gold Monetisation Scheme (GMS). Under this scheme, the minimum deposit size fell to as little as 30 grams, with interest rates up to 2.5 per cent for long term deposits (tenure of deposit is 12-15 years).

Despite this, the scheme has only seen limited success, with majority of the deposits coming from temples and Institutions, while households – the largest gold holders– lacked enthusiasm in participating. The limited success of GMS can be attributed to various factors such as lack of participation of banks, interest rates on deposits under GMS, minimum denomination on the gold deposits, and lack of CPTC (collection and purity testing centre).The scheme has mobilised 20.5t from November 2015 to January 2020.12. But this could change if the GMS scheme were structured to be more appealing to depositors, with further reduction in the threshold of 30 grams and opening of a gold savings account. By making the scheme more appealing, Indian households potentially could benefit by re-allocating outstanding stocks of gold towards financial assets. As per the RBI’s report of the household finance committee, if households in the middle third of the gold holdings distribution re-allocated a quarter of their existing gold holdings to financial assets, on average, they could earn an amount equivalent to 0.8 per cent of their annual income per year. The organised gold loan market has opportunity to grow with collateralised gold holdings of 1,280t, equivalent to approx. 5% of the total outstanding gold stocks in India. The organised gold loan market can continue to provide lending against gold jewellery both to individuals and small businesses, potentially helping to meet their financing needs. Technology has also become a key enabler in spreading the reach of gold loan business, increasing the penetration of financial inclusion through gold loan industry. The digital offerings in the form of online gold loan (OGL) scheme had become popular since inception.

Gold Loan Mkt In Covid Era

The 28.8 per cent rally in domestic gold price this year has led to increased demand for gold loans. Borrowers have benefited from higher loan value for the same collateral, while lenders have benefited from lower loan-to-value (LTV) ratios on their existing loans and higher demand. With a higher gold price and greater liquidity needs arising with the onset of Covid-19, it was believed that the pandemic would induce higher gold recycling from consumers. However, consumers used their gold holdings as collateral to obtain their financing needs rather than outright selling. Also, the rural economy has performed strongly this year, reducing the need for distress selling.

Demand for gold loans during the pandemic has been strong both through NBFCs and banks. Banks have aggressively promoted and launched gold loan schemes since the outbreak to capitalise on these lucrative schemes.

Banks Promoting Gold Loan Schemes

SBI reduced interest rate on gold loans from 7.75 per cent to 7.5 per cent with loan amount up to Rs50 lakhs (Rs5 million) ICICI home finance launched a gold loan scheme with option of bullet payments, fixed interest rate and foreclosure payment option with interest on gold loan in the range of 12-21 per cent with loan amount ranging from Rs10,000 to Rs10 lakhs (Rs10,000 to Rs1 million) HDFC expanded the number of branches in rural India offering gold loan facility Indel Money introduced a gold loan scheme with longer duration of two years. Demand during the pandemic has pushed gold loan AUM higher for India’s leading gold loan NBFCs – the AUM of Muthoot Finance and Manappuram Finance increased by 15 per cent and 33.4 per cent y-o-y respectively in Q2 2020.18 Kerala-based bank Federal bank reported 36 per cent increase in gold loan AUM y-o-y in Q2 2020. Indian Bank has witnessed 10 per cent increase in average ticket size of gold loans to Rs88,000. Recent industry interaction and media articles have also mentioned higher demand for gold loans.

The writer is a business journalist with 27 years of experience

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