Abandoned gold loans are India8217;s 8216;jingle mail8217;,says Andy Mukherjee

Borrowing against gold is popular among those who have trouble getting conventional loans.

The myth that Indians8217; love for gold is driven by tradition rather than financial self-interest has been dashed. Falling prices have prompted borrowers who took out loans secured against the yellow metal to break a cultural taboo and abandon their collateral. It8217;s the Indian equivalent of American homeowners who walked away from their underwater mortgages by mailing the keys to their homes to the bank.

India8217;s version of the 8220;jingle mail8221; came to light when Manappuram Finance,a lender against gold,recently warned that defaulting borrowers would force it to report a quarterly loss. The lender8217;s Mumbai-listed shares tanked 31 percent over just three days. The precipitous fall was partly due to concerns the company had selectively leaked its guidance 8211; a charge Manappuram denies. But clearly the lender,which was forecasting a profit as recently as February,had underestimated the borrowers8217; response.

Borrowing against gold is popular among those who have trouble getting conventional loans. The formal gold loan market has about 30 billion in assets; the pawnshop-dominated informal market is probably several times as large. As recently as the fourth quarter of 2011,companies were offering to lend 100 against jewellery valued at just 110. With annual interest rates at around 26 percent,it only made sense to repay the loan if the value of the gold had risen to 126. But the local-currency price of the same gold has now fallen to about 105.

Last year,India8217;s central bank acted to contain the risks. It restricted finance companies from making loans exceeding 60 percent of the value of gold held as collateral. But deals that were struck at higher loan-to-value are now under water. Lenders have little choice but to seize the collateral,and take the hit to their earnings.

In January,a panel set up by the central bank recommended loosening loan-to-value ratios on gold-backed credit to 75 percent. The ongoing fiasco shows that any such move could be fraught with risks. It isn8217;t the subprime borrowers who pose a threat to the system. They will simply behave in their self-interest. It is the lenders8217; ability to act in the interest of their shareholders that can8217;t be taken for granted.

CONTEXT NEWS

8211; Shares in Manappuram Finance,an Indian finance company that lends money against gold,fell 31 percent between March 19 and March 21 after the company forecast up to a 500 million rupee 9.2 million loss in the current quarter.

8211; The lender says it may not receive 2.5 billion rupees or about half of the interest it has earned on its gold loan book of 15 billion rupees as it anticipates some borrowers will default strategically and not redeem their pledged gold,which now costs less than it did between October and December 2011,when most of the problem loans were made.

Story continues below this ad

8211; In a March 21 statement to the National Stock Exchange in Mumbai,the company denied allegations that it had disclosed the projected loss selectively to one analyst on the afternoon of March 18,a day before discussing the earnings guidance with investors on a conference call.

8211; Reuters: India8217;s Manappuram Finance says expects revenue under recovery on certain gold loan portfolios