Saturday, June 16, 2012

Tough Times Ahead for Gold Loan Companies


How many of you have actually noticed the fact that companies that issue loan against gold like Manappuram or Muthoot have been sprouting up in almost every single locality in your city? Over the past 5 years, these companies have grown in leaps and bounds. The sky-rocketing price of gold and easy access to cash without much of a hassle if customers pledge gold has fuelled the growth of these companies and they have grown to such an extent that, they have even gone public and issued Equity Shares. Though this might sound an Amazing Growth Story, the future for these companies doesn’t look like it will be as fast paced as it has been over the past few years. The purpose of this article is to analyse on that aspect…

How Does a Gold Loan Work?

This is something almost 99% of you would know, but for the sake completeness, I am writing this section.

The company (or Bank) take possession of customer’s gold (Jewellery) and grant loans of around 70% or more of the value of the current value of Gold as loan. The customer will pay a monthly interest (around 2-3% of the sum borrowed) and can take their gold back when they settle the entire amount due (principal borrowed + interest).
If I fail to repay the interest for a period of 3 consecutive months (depends on the company) they have the right to sell my gold and offset their loan cost and reduce their losses

What is a Gold Loan Company?

A Gold Loan Company is one that is into the business of lending money against Gold. Though Banks also lend money against gold, they also accept deposits and provide bank accounts to customers. These Companies do not provide such services. The only service they provide customers is loan against gold jewellery. As a result some people even refer to them as NBFC’s (Non-Banking Financial Companies)

Tough Times Ahead for Gold Loan Cos

You might be wondering if what I have put in the title is true… Are you?
If you are, I wouldn’t be surprised and in fact that is a good start for the both of us. The following are some reasons as to why the following few months (or maybe even years) are going to be tough for these companies.

Reason 1: Regulatory Concerns

Seeing the super-fast growth of these companies (partly due to very little regulations) the Reserve Bank of India has starting setting up guidelines for these companies. Though the RBI Governs all Banks in India, these gold loan cos were not entirely under the RBI’s jurisdiction. Now, the RBI has started setting up some rules. As a result, these cos will be facing some uncertain times in the near future at least until there is some clear cut clarity on the kind of regulations they are expected to follow.

A Full list of the recent regulatory changes for gold loan cos is available at the end of this article.

Reason 2 – Explosive Growth is not permanent

Any new industry fancies customer interest for a few quick years and then starts to stabilize. These gold loan cos too are part of that cycle. The arrival of these companies that offer much higher amounts against Gold sparked customer interest and over the past few years, these companies have grown at super-duper speeds. However, now things are starting to stabilize.

I am not saying that there will be no growth. All I am saying is, the growth will not be as spectacular as it was in the past 2 to 3 years.

Reason 3 – Competition

With the arrival of multiple Gold Loan Lenders, competition is pretty heavy. Newer entrants are offering much lower interest rates than the veterans. As a result, customers in need of a better bargain are flocking towards the new entrants because the interest they are paying is comparatively lesser. Due to heavy competition, all these lenders are forced to cut their rates which in a way is good for the customers.

Reason 4 – Growth in Gold Loan Lending by Commercial Banks

A few years back, only a few select private banks offered loan against jewellery. But, things have changed and almost all banks these days are offering loans against gold jewellery. With no upper limit on Loan-to-value ratio (like Gold Loan Cos) banks can lend a much higher value loans for the same quantum of gold to customers. So, customers might choose to borrow from banks instead of these gold loan cos.

Recent RBI Rulings that might affect Goal Loan Cos

Ruling No. 1:
The RBI came up with a new ruling on 21st March 2012 which prohibits exceeding a 60% Loan-To-Value Ratio. This means, the RBI prohibits Gold Loan Cos from lending more than 60% of the value of Gold Pledged by the customer (It was 75% earlier).

Impact:
The amount that customers can borrow will come down. In other words, a customer has to pledge more gold in order to get the same loan amount as to what he/she got just a few months back.

Ruling No. 2:

The Tier-I Capital Adequacy Ratio (CAR) requirement has been increased to 12% (It was 10% earlier). This will be effective April 1st 2014.

Impact:

CAR is nothing but the amount of liquid cash these companies have to maintain as a ratio of the loans in their books. For ex: If XYZ Gold Finance Co has granted gold loans worth 10 crores, they had to keep liquid cash worth at least 1 crore to meet the Tier I CAR. As a result of this new ruling they have to keep 1.2 crores (additional 20 lakhs) for the same loan amount of 10 crores.

This will be a huge dent in their books. Instead of using surplus cash to lend more loans and increase revenue, they will be forced to keep the money to meet capital adequacy requirements. Moreover, this 10 crores is probably the amount of loans a big gold finance co might grant in a week or even less. So, if we consider the amount of liquid cash they need to keep to maintain the CAR Ratio, the number might run into a few hundred Crores.

Ruling No. 3:

RBI has prevent Gold Loan Cos from granting loans against Bullion

Impact:
Customers who have gold bars (bullion) will not be able to borrow money against it. Only Jewellery can be used to borrow money. This will affect the small minority that use bullion to take loans.

Future for Gold Loan Cos?

An RBI Constituted working committee is working on formulating a list of rules & regulations for these gold loan lenders. This is expected to be released by July or August of 2012. So, until then, times will be uncertain for these guys. Even after the rules are made public, these companies will be forced to make radical changes in their operations which might affect their profits for at least one or two years. So, if you are an investor looking to invest in these gold loan cos, it would be a good idea to wait until end of this year to see how things work out for these companies before investing in them.

4 comments:

  1. It's almost too funny, if it were not so sad.
    .
    Ever imagine a high-income or high-net-worth individual going out to Muthoot finance? Nah, never, not a chance. Who goes to these places? People whose entire net-worth is less than INR 1 crore (more commonly people whose income is between 2 to 10 lakhs per-annum). The lower economic classes have to live with loan-sharks & pawn-brokers - nothing can change that. So, by this smart regulation the GoI is forcing *only* the middle-class people to get lesser loans against their gold - why?
    .
    The road to hell is almost always built with the best intentions in mind. NY city has recently put a ban on large-volume sodas from being sold in certain areas - because many people in NYC are obese. This regulation (by RBI) is not much different.
    .
    With the alarming growth in inflation and the impending stag-flation that is about to consume India & annihilate the economy, the GoI has noticed that the import of gold has been soaring. India imports one of the highest volumes of gold (next only to China, I believe) - and most of it just sits in one safety-locker or another (only a small percent is worn or used daily by anyone).
    .
    By reducing the amount a middle-income earner can get for his gold, the GoI is forcing anyone in a precarious situation or dire need of money urgently to *sell* their savings (in gold). This is a back-door method to try & pull out the gold being saved by middle-income people. Let's talk about Sivaramakrishnaganapathysubramanian - our average guy in Chennai. Siva aged 28 has a B.Com degree & earns monthly 15,000 and lives with his mom, dad. His dad spent all his retirement in repaying their home-loan and spending for the marriage of Siva's sister - right now, the family owns a small 1 bed apartment in the suburbs - say Porur. All of a sudden, Siva's dad has a heart-attack & it is going to cost the family 5 lakhs (due to a complication in dad's health). Earlier, Siva would pledge his mom's jewels and would be able make-do (with small helps from friends & relatives); not any more. Now, thanks to RBI, Siva will either have to sell off the jewels or have some good connections in the nearest bank (a bank manager or some other chamcha of the manager).
    .
    While banks can run crores of INR in their books as NPA (Non-Performing Assets), the RBI is more concerned about private entities that are taking a risk & making a profit. All this - in the name of public good. As long as there are sheeple - there will be more Hitlers.
    .
    Now, imagine where all of the gold will go? If it were merely pledged, Siva may have been able to pay out the money & get the jewels back (the cost of a gram of gold is irrelevant to this transaction). But, now, if he had sold them - then he will have to pay sales-tax to purchase new jewels. And I doubt if Siva will be able to put in 2600 INR per gram to buy too much of gold. There is the risk of gold prices tanking - in which case Muthoot (or any other entity that loaned money to Siva) will stand to loose - that is the risk for which they are getting interest. Every business has a risk - and a corresponding reward. From what it looks, gold prices are not going south anytime soon. With stagflation consuming the Indian economy, gold may be the smartest thing to own. This step by RBI will ensure that the middle-class people no longer own as much gold as they used to. More & more gold will slowly get passed to the richer people that have the money to purchase it.
    .
    As always - these are just my opinions. And, as always, it is refreshing to read your posts. Keep up the good work, Anand. I do appreciate it very much.
    .
    MN

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  2. The above information is good because it describes how gold loan actually work and what are the different companies who sell gold loan at cheapest rate of interest. I was also planning to buy a gold loan but before that i want to know the detailed and working procedure of gold loan which i got from this blog.

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