Gold loans are glittering a bit more this financial quarter. The latest Reserve Bank of India (RBI) data shows that loans against gold have increased by a whopping 82 per cent since March last year.
Experts believe that the surge in gold pledging can be attributed to the intense economic distress caused by the COVID-19 pandemic. While lakhs have lost their life savings in COVID treatment, many small and medium enterprises are looking for capital to tide over the enormous losses incurred since 2020.
Gold has been considered an age-old form of investment in the country, especially in south India. It is one of the biggest gold markets in the world. Indians prefer gold not only for its monetary value, but because of a certain emotional attachment as well. Gold ornaments are handed down through generations and are used as collateral to raise quick capital.
According to the World Gold Council, the average Indian household holds 84 per cent of its wealth in real estate and other physical goods, 11 per cent in gold and the rest five per cent in financial assets. Dependence of rural households in physical assets such as gold has been a result of not just love of gold, but also poor banking penetration till lately.
Organised and unorganised sectors
Indians generally prefer pledging gold rather than selling it as the yellow metal holds emotional significance for them. Traditionally, they have mortgaged their gold to local lenders and pawnbrokers for short term spendings. Over the past few years, banks and non-banking financial companies (NBFC), which form the organised sector in the gold loan landscape, have extended loans against gold. However, the majority of the market is still dominated by the unorganised sector.
A report titled ‘Return of Gold Financiers in India’s Organised Lending Market’, published by accounting firm KPMG, said that the organised gold loan market comprising banks (public, private, small finance and co-operative), NBFCs and Nidhi companies contribute to only 35 per cent of the Indian gold loan market.
MD and CEO of Manappuram Finance Ltd., VP Nandakumar, said in a report: “This business was the preserve of the unorganised sector, the pawnbrokers and moneylenders who operated in lanes and bylanes across the country, away from the oversight of regulators and policy makers. Indeed, India’s regulatory and policy making establishment (and also decision makers in the banking sector) were largely uninformed about gold loans and why it mattered to so many ordinary Indians.” The unorganised sector is still preferred for gold loans because the players are known to provide quick cash with little documentation, making it easier for the unbanked population with no credit score to secure a loan.
The perils of pledging gold in unorganised sector
High Interest rates: The foremost disadvantage of pawning your gold with the local money lender is the high interest rate. Since the players are not regulated, the loanees are highly susceptible to financial exploitation by the lenders.
While NBFCs charge an interest rate of 11-24 per cent and banks charge between 7-15 per cent per annum, local lenders ask for anything between 25-50 per cent for the same period.
An official working with a major public sector bank said: “Apart from low interest rates, the process to secure gold loans from banks has also become easier with customers now being able to apply for a loan online. The process does not take more than an hour. With the Pradhan Mantri Jan Dhan Yojana, a large portion of the previously unbanked population has bank accounts now, making it easier for us to penetrate the market.”
Major NBFCs provide doorstep gold loans where an agent visits the house of the customers to evaluate the gold assets. Unlike banks, they take more risk and lend to customers with low credit scores.
Low assurance of getting back valuables: Formal institutions follow a transparent process of returning your gold once the tenure is over. You can remain assured that after the loan repayment period, your valuables will be handed over to you.
An official who deals with gold loans in a national bank said: “In case of a gold loanee defaulting on payment, it is the prerogative of the bank to get rid of the gold and get its money back. That is why, a standard procedure is followed before the gold is declared a non-performing asset (NPA) and auctioned off. After a couple of reminders to the borrower, a notification is published in newspapers about the auction in order to give every chance to the customer to reclaim their gold. These processes don’t exist in the informal sector, making local moneylenders less accountable for the collateral.”
Dubious valuation: You are more likely to get the genuine valuation of your assets in banks and NBFCs than in the unorganised sector. The amount of loan that can be raised against gold depends on the value of the gold, and pawn brokers can take customers for a ride easily by quoting a lower price of the pledged valuables.
No fixed LTV: Loan-to-Value ratio (LTV) is the amount of loan against the gold you can avail on the value of the gold you possess. “This value has been fixed by the RBI to be 75 per cent. But lenders in the unorganised sector are under no binding to follow this and often offer lower LTV,” said a branch head of an NBFC.
Sensing the distress in the economy, the RBI had raised the LTV to 90 per cent for banks last year, so that people could raise more money against the yellow metal.
Security: Once you pledge your gold coins, bars or ornaments with a regularised institution, you can be assured that the assets will be stored safely. Banks and NBFCs invest in high-end security systems to keep the mortgaged valuables safe. In case of theft, they are liable to compensate their customers for the losses. But this assurance can hardly be given in the informal market.