As low-income individuals and small businesses continue to experience declining incomes, the gold lending business is a booming segment for commercial banks and non-bank financial firms. As people pledge their gold jewelry for emergency cash, banks reported a 45% increase in outstanding gold loans in December 2021, from last year. As the business continues to boom, the question remains: is it beneficial for the borrower to sell or pledge gold, and who should take out such loans?
The increase in loans
Total gold loans outstanding from banks increased by 45.1% to Rs 70,871 crore in the 12 months ending December 2021. Compared to March 2020, when it stood at Rs 33,303 crore, outstanding gold loans have increased by 112% over the past 21 months. The business took a big leap when the Covid-19 pandemic hit the country in March 2020 and people started pledging their gold to meet health, agriculture, marriage and education expenses. PSU banks have now started focusing on this segment considering the trend.
Although this is RBI data and relates to the activities of banks, industry experts say that if one includes loans made by gold lenders such as Muthoot Finance and Manappuram Finance, the outstanding amount will be much higher.
How the loan works
The loan to value ratio (LTV) when pledging gold is 75%: the borrower will only get 75% of the value of the gold they pledge against the loan. If the borrower does not repay the loan, he will have suffered a loss, because he will not have obtained the full value of the gold. The best option is to sell the gold and get its full value in an emergency. The borrower can always redeem gold in stages on the market when his financial situation improves. On top of that, the interest rate of non-bank gold lending financial corporations (NBFC) in this era of low rate regime stands at 12-18%.
According to India Ratings, unlike other secured loans – such as two-wheeler, utility vehicle or home loans – where the collateral stays with the borrower and is only taken over in the event of default, the collateral a gold loan belongs to the lender for the duration of the loan. In the event of default, the entire collateral will be auctioned off by the lender and the money will be recovered. Since gold is a price-sensitive commodity, any default on gold loans generally beyond 90 days calls for an auction, in accordance with the originator’s internal policies. Thus, up to 90 days, the lender strives to recover the loan; beyond that, efforts go towards a gold auction.
Should I take out a loan?
In line with all interest rates in the economy, interest rates on gold loans are also low. The State Bank of India offers loans at 7.3%. However, low rates shouldn’t be the only reason individuals or small business owners opt for a gold loan. Experts say taking out a loan in these times could be both a good and a bad idea depending on who you are and what you’re borrowing for.
Taking out a loan for consumption needs or to finance a wedding may not be a good idea if your income is under pressure. if you are unable to repay the gold loan, you run the risk that the financier will sell the gold you have pledged.
However, if the loan is intended to fund short-term working capital needs and cover a stretched payment cycle, experts say it’s fine to go.
“For a small business owner whose need is driven by an uptick in the payment cycle and who is looking to cover a gap for a few months, that’s not a bad idea,” one expert said.
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