Gold as risk insurance in India

Tamal Bandopadhaya has a very informative oped on the gold loan market in India. It highlights the risk insurance value of gold for households, the ease of borrowing and lending against gold, and the challenge with micro-prudential norms for gold loans etc.

On the volume of the gold loans market,

The household gold holding in India, the second biggest consumer of gold after China, could be as much as 25,000 tonne. The pandemic had led to a 94 per cent drop in gold import during the first quarter of 2020-21 but the scene has changed. In February, gold import surged almost 124 per cent after a near 155 per cent rise in January... A January 2020 report of consultancy firm KPMG pegs informal lenders’ share in the $46-billion gold loan industry at 65 per cent. By its estimate, India’s gold loan market is set to expand by at least 34 per cent to $61 billion in two years to March 2022... The traders typically take gold loans as bridge financing to take care of temporary cash flow mismatches; individuals go for it for emergencies, particularly medical needs.

Who are the major actors in the gold loan market,

Offering loans against gold has traditionally been the business of a handful of NBFCs such as Muthoot Finance Ltd, Manappuram Finance Ltd and Muthoot Fincorp Ltd. But banks and even small NBFCs started grabbing the opportunity with both hands last year as consumers, including those at the so-called bottom of the pyramid, had shed their inhibition and were willing to monetise gold by taking loan when their cash flows dried up in a shrinking economy, hit by the Covid pandemic.

On the ease of lending and borrowing against gold,

One needs to simply dial a number to get all information about the product at SBI. The bank also reaches out to customers, basis a missed call or a text message. Most lenders have adopted a similar strategy... there are many benefits for borrowers who can get the loans in the comfort of their homes or through on-line channels. When a consumer asks for a gold loan, she gets a free valuation of the gold that she offers as collateral. Besides, as the lender keeps the gold in its vault, it’s free safe-keeping of the borrower’s assets. The financing is immediate if the purity of gold is certain, and the cost of gold loan is relatively cheaper compared with other loans.

On how Covid 19 episode made its value evident for households,

Till January, bank credit had shown a measly 5.7 per cent growth over the previous year. The pace of growth in retail loans, the main driver of bank credit in India for the past few years, slowed down to 9.1 per cent year-on-year in January against 16.9 per cent a year ago. But loan against gold, the new-found love of Indian bankers and borrowers, staged a phenomenal 132 per cent growth during this period. From a low base of Rs 18,596 crore, the ind­us­try’s gold loan portfolio zoomed to Rs 43,141 crore... In the past one year, most ban­ks and NBFCs have been aggressively pushing for gold loans. The State Bank of India’s (SBI’s) gold loan portfolio jumped to Rs 17,492 crore in December, rising from Rs 11,509 crore in just three months since October 2020. The nation’s largest lender is offering gold loans at 7.5 per cent.

This build-up has been having its consequences,  

In the past few weeks, quite a few advertisements have been put out in newspapers by banks and non-banking financial companies (NBFCs) on gold auctions. The lenders are selling gold to recover dues from their borrowers. Some bankers, in private, are saying they are seeing the first signs of rising defaults... Gold prices are down close to 20 per cent from the record high of Rs 55,922 in India early August 2020. Since January, the prices are down by almost Rs 6,000. In the second week of March, the price dropped to a recent low of Rs 44,177; since then, it has risen around 1.5 per cent. The drop in gold prices is at the root of the problem — both for bankers and borrowers. For instance, if a bank has given a loan of Rs 90,000 against Rs 100,000 worth of gold pledged (at 90 per cent loan-to-value or LTV — the percentage of the loan that can be disbursed against the value of gold pledged), a 20 per cent drop in value increases the risk for the bank. Why? The amount of loan given becomes higher than the value of the collateral. In such a scenario, the borro­wers are required to bring in more gold to add to the collateral or prepay the loan. Some borrowers may not be able to replenish the collateral or don’t have the money to close the loan. A few smart ones even may choose not to pay back or bring in more gold (even though they have both) and decide to dump the gold already pledged, with the bank, as its value is less than the money taken from the lender. This is why probably we are seeing gold auctions... Muthoot Finance, which had a gold loan portfolio of Rs 37,724.5 crore in December 2019, has seen it rising to Rs 49,622.5 crore in December 2020. During this period, its gold holding actually came down — from 173 tonne to 166 tonne — because of the drop in gold prices. During this period, Manappuram Finance’s gold loan portfolio had risen from Rs 16,242.95 crore to Rs 20,211.48 crore but the gold holding dropped from 73.5 tonne to 68.2 tonne. The NBFCs follow a lower LTV ratio for such loans.

Three observations

1. The value of gold as a risk insurance hedge for poor and middle-class households and small traders, who form the overwhelming majority of the credit market, is not going to diminish any time soon. It is not easy for formal finance to address this problem. On both cost and convenience, formal finance is way behind. 

2. Both the explosive rise in gold loans and the rise in defaults in the formal market can be taken as representative of the gold loan market as a whole. Further, given the very large share of informal lenders in gold loan business and given those borrowers are even more likely to default, we get a clear picture of the distress associated with Covid 19. 

3. The explosive growth in gold loans and the persistence of NRGES demand are some of the very few indicators of enduring weakness in the dominant informal sector.