Brisk growth in gold loans likely behind RBI warning

The Reserve Bank of India’s (RBI) caution on gold loans is likely on account of the brisk growth in the segment, analysts said, but a secured asset class like bullion would still present fewer risks than what was seen in personal loans.

On Monday, the regulator flagged deficiencies in gold-lending practices in using third-party agencies, besides inadequate due diligence and monitoring of end use of funds. Outstanding gold loans grew 41% year-on-year (y-o-y) in August to ₹1.4 trillion, according to data from RBI. The growth rate was double of what was recorded in August last year. So far, this financial year, gold loans are up 37%.

Reacting to the RBI notification, shares of gold loan companies Muthoot Finance and Manappuram Finance closed 3.7% and 1.9% lower, respectively, on Tuesday.

Read more: Gold prices may fall in the coming months. Here’s why that’s great news.

“A robust increase in gold prices has pushed up the loan book growth in the recent past, which in turn, has brought the segment under spotlight,” said A.M. Karthik, senior vice-president & co-group head, financial sector ratings, Icra.

Karthik said that in the case of gold loans, one must remember it is a secured asset class targeted towardsretail and agri borrowers. Such lending, however, is highly regulated around various operational aspects, including branch opening, collateral evaluation and storage, auction process, among others, he said.

The RBI found several violations in gold loans advanced through partnership with fintechs and business correspondents (BC), according to the regulator's notification on Monday. These include valuation of gold being carried out in the absence of the customer, the metal being stored in the custody of business correspondents and delayed and insecure mode of transportation of the precious metal to the branch.

Karthik said that the RBI notification on various practices in the gold loan business could result in some strong and well-placed players attracting more demand, while others wouldbe required to make appropriate process changes. “It shall impact lenders that rely on fintechs/BCs (business correspondents) in view of the shortfalls highlighted when third parties are used for loan sourcing.”

Monday’s was RBI’s first major industry-wide caution against certain gold loan practices of banks and non-bank financiers. However, there have been sporadic cases in the past. In March, RBI barred non-bank lending IIFL Finance from giving out gold loans. In a statement, the regulator had said there were “serious deviations” in assaying and certifying purity and net weight of gold at the time of sanction of loans and at the time of auction following a default. It also flagged disbursal and collection of loan amounts in cash, which was far in excess of the statutory limit, among other issues. The ban was removed after six months on 19 September.

Suresh Ganapathy, managing director and head of financial services research at Macquarie Capital, said in an email to clients Tuesday that history has shown that whenever there has been a rapid rise in any segment, it has inevitably resulted in higher non-performing loans and stress.

Read more: All that’s gold needn’t glitter: There’s paper gold

“Hence, in a strict circular yesterday, they have come up with some rules and regulations and have warned everyone … ‘I am giving you three months … Get your act together otherwise face regulatory ire/action,’” wrote Ganapathy.

The government has also tried to take a closer look at practices surrounding gold loans at state-owned banks. According to news agency PTI, the finance ministry directed all state-owned banks to review their gold loan portfolio as instances of non-compliance with regulatory norms have been noticed by the government. The Department of Financial Services (DFS), in a communication addressed to heads of public sector banks, has asked them to look at their system and processes related to gold loans, PTI reported on 14 March.

Mint had also reported on 5 February how employees at a clutch of Bank of Baroda (BoB) branches disbursed fake gold loans last year to meet stiff targets, breaching regulatory guidelines. These breaches were primarily at branches with so-called gold loan shoppes, or private enclosures to serve gold loan customers.

Some analysts said that RBI’s warning is a positive for established gold lenders like Muthoot Finance as their processes have been refined through several decades of RBI audit.

Read more: Cut the clutter: The art of subtraction to simplify your personal finance

“Given gold loans is their core business, the reliance on third parties for sourcing, appraisal, etc. is minimal, unlike a few of the banks and other diversified NBFCs/fintechs,” analysts at Sanford C. Bernstein said in a note on Tuesday. The gold loans have emerged as the latest stop in RBI’s quest to regulate credit growth in consumer segments, they said.

“There could be some areas where they are similarly positioned vs. other lenders - e.g. rolling over loans at the end of tenor, monitoring of end-use of loans, etc. but we expect pure-play gold lenders to be at an advantage in addressing the gaps, if any.”