Tough Times Ahead for Gold Loan Companies - All Your Questions Answered

After reading the last article titled “Tough Times Ahead for Gold Loan Companies” there might be some questions running in your mind. I have tried to answer some of the main questions. If you have any further questions, feel free to leave a comment and I will be more than happy to answer them…

1. Why do customers prefer these Gold Loans?

Let us say I am in urgent need of cash and taking a Personal Loan would take at least 4-5 working days after I submit all the necessary paper work. While I am wondering what to do, my Mom tells me that, I can pledge her Jewels in the nearby Gold Loan Co and get some cash quickly. I take 5 sovereigns (40 grams) of her jewellery and visit the place. The person in the Gold Loan section checks the weight of the jewellery and its quality and gives me a quotation. The price of gold today is going at over Rs. 2600/- per gram which means the necklace is worth a little over 1 lakh. The Gold Loan Co offers me quick cash of Rs. 75000/- on hand and takes possession of the jewellery. I will have to pay a monthly interest and can redeem my mom’s necklace once I repay them the principal of Rs. 75000/-

All things done & dusted in a few hours. Some Gold Finance Companies even advertise super-fast service times like – “Get Cash in 15 mins” and so on to attract more customers.

Most Importantly – This is an extremely better option when compared to loan sharks and illegal lenders who charge exorbitant interest rates and harass customers.

2. How does the 60% Loan to Value Ratio affect Gold Loan Cos?

If, I were a customer, I would have to pledge more gold than before to borrow the same amount of money. Similarly, these companies would have to stop selling certain products which offer more than 60% the value of the gold as loan. Existing customers who are used to getting around 75% of the gold value as loan will end up disappointed as well which will not do much good for the business.

3. Is this 60% Loan to Value Ratio applicable to Banks that offer loans against Gold?

No. This ruling by the RBI is applicable only to NBFC’s that offer loans against Gold. Before you say, this doesn’t make sense, just read the next question/answer which will clarify further on this.

4. Why doesn’t this 60% LTV Rule apply to Banks?

The RBI Feels that, these Gold Loan Cos are growing at an alarming pace and them granting loans of over 75% of the Gold value might adversely affect their business. This whole loan thing is based on the fact that Gold price will not go down. Let’s say, I borrow 10 lakhs against 12 lakhs worth of my Gold Jewels. After a few months, the price of Gold tanks and my gold is worth only 9 lakhs today while the loan I have taken is still worth 10 lakhs only. Will I repay 10 lakhs to take possession of my gold that is worth 9 lakhs? Probably not. In such a situation, such NBFC’s will be forced to declare bankruptcy. To avoid such a situation RBI is setting this 60% LTV ratio so that these gold loan cos have some buffer.

The second part about Banks not being brought under this rule is because – banks can accept customer deposits and as a result have much more cash at their disposal than these Gold Loan Cos. As a result, they can absorb/survive a much higher impact than NBFCs. So, RBI does not mandate this 60% LTV ratio for Banks.

Technically & practically speaking a rule must be common across the board but unfortunately in this case it is lopsided against these Gold Loan Cos.

5. With no upper limit on LTV, can commercial banks kill the private gold loan cos?

Though it is practically possible, banks usually don’t lend amounts beyond 15 lakhs as loan against gold. This upper limit on the loan value is something that almost all banks have. Private gold loan cos don’t have this limit. They will lend you as much money as you want provided you have enough gold to pledge…

Also, banks have a lot of formalities which private lenders don’t. Can you imagine walking into State Bank of India or any other Public Sector Bank and walking out with money in say even 2 hours? I must be out of my mind to suggest something like that. Even private sector banks will make you wait at least a few hours to disperse the funds. Whereas, these gold loan cos will give you cash in a matter of minutes or at most 1 or 2 hours.

So, customers wanting quick & unlimited money supply would still prefer these guys over banks.

6. Does the Capital Adequacy Requirement increase to 12% affect large players like Muthoot or Manappuram Finance?

No. Muthoot maintains a CAR of around 13% and Manappuram maintains a much higher CAR of 18%. So, there will be no impact on either of these companies.

7. Banks have been offering loans against gold for years but, these Gold Loan Cos have out-grown the gold loan lending arm of banks. How was this possible?

There are numerous reasons. Some are:

a. Quicker service – Banks concentrate heavily on their main business like bank accounts, deposits etc. and grant gold loans as a parallel activity. So, service will not be top class. Whereas, the only job these gold loan cos have is granting loan against gold. So they will be much faster.
b. Well-Trained staff – the staff of a gold loan co can check the purity of gold and value it accurately while banks depend on experts who are not full time bank staff. So, there is bound to be some delays
c. Lesser Charges – Banks usually charge a processing fee (1% or so) while these Gold Loan Cos don’t. Also, banks charge a penalty if the loan is repaid within a certain duration (say 6 months or so) whereas Gold Loan Cos don’t.
d. Lesser Salaries – Salaries & Perks that Bank Staff receive a much higher when compared to what the staff of Gold Loan Cos get. So, companies can offer loans at competitive rates when compared to Banks.

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.