The explosive growth in the gold loan business to about Rs 75,000 crore in a short time has raised many red flags over the systemic risks it poses to the financial sector. Economists and financial market pundits are even worried the gold loan business may turn out the way micro-finance did after the initial boom.
Lax regulations have let non-banking finance companies such as Muthoot Finance and Manappuram enjoy a free run. They deliver loans in 15-30 minutes with little or no regard to KYC (Know Your Customer) norms. Besides,there is no regulatory limit on the interest rate they can charge at times,the rates top 26-32 per cent. The repayment period can be altered depending on the convenience of both the lender and the borrower. Besides,non-banking finance companies are not regulated and watched as closely as banks by the Reserve Bank of India (RBI).
Theres another worry. Gold prices rose through 2011 and ended the year with a 36 per cent surge. The situation can quickly turn uncomfortable if prices crash by the same margin or even more in 2012. Will gold loan firms survive such a fall? If they are unable to repay the money raised for lending to customers from the market,it will impact other financial players such as mutual funds and banks.
There are two inherent risks typical to the gold loan business,points out Biju Pillai,senior executive vice-president,HDFC Bank,the biggest player among private sector banks today. Credit or operations risk,the capability of the borrower to repay the loan,and collateral risk,the ability of the lender to sell the gold and recover the loan in case of a default, he said.
HDFC Bank lends about 70 per cent of the value of the gold. Besides,a margin of 5-10 per cent is kept while calculating the value itself. Banks are also strictly monitored and governed by the central bank on their business practices. Given the checks it carries out on customers,giving a gold loan is better than extending an unsecured loan,said Pillai.
M Narendra,Chairman and MD of Indian Overseas Bank,also a big player in the business,said they dont give more than 50-60 per cent of the value as loan and their interest rate is half of NBFCs. We are very conservative in this business, he said.
In case of NBFCs,the problem starts with the high loan-to-value ratio of 85-90 per cent. Muthoot and Manappuram at best ask for an identity proof and an address proof before they disburse the loan. So,they really do not have an idea if a borrower will return to repay and take back the gold if prices plummet,by say 40-50 per cent.
Muthoot admits that in the case of a default,it is not sure if it will be able to sell the pledged gold jewellery at prices sufficient to cover the amounts. But it claims its gold loan policies are as stringent as in banks.
Not all bankers are sanguine either. The going will be good as long as the bullion boom lasts. Once signs of trouble come in,we dont know how its going to hit the system… Experts had forecast that housing boom in the US will never fail,but we saw a prolonged bust later, said a banker who didnt want to be identified.
Another big worry is the systemic risk that NBFCs collapse can pose to the financial system. Gold loan companies themselves are big borrowers. Total liabilities of Muthoot Finance amount to Rs 18,109 crore in fiscal 2011. Of this,Rs 7,592 crore is cash credit facility from banks,Rs 5,849 crore through non convertible debenture (NCD) issues from the market and Rs 2,198 crore through commercial papers.
Manappurams total debt was around Rs 5,653 crore as of March 2011 which inluded working capital loan of Rs 3,055 crore from banks.
The Reserve Bank of India has raised red flags. In a recent working paper calling for tighter norms for NBFCs,it said: The higher borrowings of NBFCs,especially from the banking system,raise some concerns about their liquidity position. More so,if such reliance happens to increase further… These concerns will be further accentuated in case the banks own liquidity position becomes tight at the time of a crisis or even in a crisis-like situation… More than 68 per cent of the consolidated balance sheets (of NBFCs) constitute borrowings.
NBFCs have been regularly raising money from the market through debentures after the RBI removed such lending from the priority sector and bank funding to them declined, Bammi of KPMG said.
Another worry is the storage of pledged gold. A leading gold loan company admitted that it doesnt have strong rooms in some of the branches.
In its NCD offer document of December 2011,Muthoot Finance laid out its security procedure in detail: The pledged gold jewellery are separately packed by staff,and then placed in a polythene pouch with the relevant documents on the loan and the customer and stored in the safe or strong room of the branch. The safes and strong rooms… are built per industry standards. The strong rooms are vaults with reinforced concrete cement structures. Currently,almost all of our branches are using strong rooms.