Financiers who lend keeping gold as collateral aren’t always enjoying the jewellery. Gold in hands of a financier glows differently than in the hands of the public. In India, gold has been the other real asset people value and trust which could help them under any financially stressed circumstances.
Only three NBFIs Muthoot Finance(the segment leader), Manapuram Gold Loan, IIFL Gold loan.
Banks and brokers:
The unorganised lenders and the organised lending by banks are the threat to gold financiers, apart from the same business competitors. Pawn Brokers who have been in this regardless of the Loan to value or the Volatility of the gold price for a long time, people opt the paperless route having no precessing fee. Having only limited parameters can be altered to attract customers the shift from the conventional business dynamics is still difficult for the organised financiers to keep themselves in business. Gold availability in India is huge and the financiers are trying to tap them out from the holders to get financed, with too many firms with low entry barrier the market share is spread among firms. As banks’ core income is by making loans and not gold loans, they still acquire part of the gold business.
Gold Price fluctuation:
When the economy struggles to grow, capital markets are highly correlated with the economy and prices come down because of lowered upcoming profit expectations. The cash from the capital markets gets infused in gold thus keeping gold prices negatively correlated with the stock prices.
The price of gold is driven by many macroeconomic factors, which dictates the business. Inflation in the US alerts the portfolio managers to add some more gold, the monetary policy rates, which make a strict/loose supply of money motivating equity market to achieve new highs, the real growth in the economy, etc.
As price decreases, so does the value of the metal which directs us to the famous lending ratio Loan-to-Value.
Loan to Value:
The NBFCs taking gold as collateral should have one eye on the LTV and the other on the resale value when the gold pledged is left serviced. Gold financiers always lend for less than 36 months and a day more than 90 will categorise the loan under NPA. This has been the problem with short to mid term lending.
As already mentioned, the price volatility of the metal cannot be predicted and people, predominantly opt for gold financing in distressed times (the gold price will shoot up). Let’s assume the rate of gold was ₹54,000 a year ago, the LTV ratio was 0.9 or 90% of the collateral, ₹48,600 is lent to the customer. As the economy recovers, price of the pledged gold comes down to ₹48,000 LTV being the same at 0.9. Since the gold price was higher when the loan was made, the amount borrowed was higher than the price of gold a year after. This is advantageous for the customer and technically default on the loan like home owners handed over the keys to the banks that made nonrecourse loans on houses back in 2007-08.
In the scrap resale market, auctioneers rate the gold below the notional value and the institutions are forced to sell them as a loan recovery process and to escape from NPA issue.
The NPA problem:
Recovering the cash from the metal. Obviously, Gold financing NBFCs are in the business to make money and not to build a portfolio dominated by gold. Gold in good times glitters less than in a pessimistic economy, because equity dominates all the asset markets and falls in economic downturns. This in Modern portfolio theory known as Perfect Negative correlation. If the loan duration is more than 3 months, the NPA is under pressure. Being an NBFC, NBFI, or a Bank, the amount of NPA is a performance gauge implying the quality of loans made.
Banks take deposits and can easily manage the risks and NPA, banks can diverse their loan portfolio to other types of lending like corporate, retail etc, to stay in business. Gold financiers are left with no options other than reducing the loan tenure and LTV, which is a safer play.