All that glitters is gold loan segment

Banks and non-banking finance companies (NBFCs) may be striving relentlessly for loan growth in the current tough economic situation, but gold loan lenders are smiling, smug in the realisation that their loan growth rates of 30% and above in the last one year represent a class act.

For instance, established gold loan player Muthoot Finance has recorded a 32% growth in loans extended as on September 30, 2011. Manappuram Finance has done even better, topping 40%. Needless to add, these figures are much better than the average bank loan growth rate of around 17%.

Here is the twist in the tale: contrary to the popular notion, gold loans are soaring not because of the ongoing rally in gold prices, but because of relatively low competition from organised lenders like banks. And having a tangible, super-secure commodity like gold for collateral can only add shine to the story.

But, surely, frequent volatility in gold prices must be a concern? No, indicates Rajiv Mehta, India Infoline analyst, in a report. “We believe that loan is essentially a function of the borrower’s requirement of fund at that time (either to meet urgencies or cash flow mismatches) which is not influenced by gold prices.”

Mehta agrees that when gold prices start to correct, customers will be forced to go in for loans with higher loan-to-value (LTV) ratio and higher rate of interest. This, he believes, will add to the risk on asset quality.

Lenders say that gold loans are largely for productive purposes like setting up a small business or agriculture. A small part of the loans, however, does go toward personal consumption. About 30% of Manappuram’s loans are taken for agriculture and allied activities.
But there are “inherent risks” in the gold loan business, says Oomen K Mammen, chief financial officer, Muthoot Finance. “A temporary fall in gold prices is something which any gold loan company can afford to deal with. Even if gold prices come down by 20-30%, we can still carry on business growth.”

From the days of very short tenures of no more than a week, gold loans have progressed to average one-year duration. Typically, most loans are repaid within four months. Not surprisingly, interest rates on gold loans have risen along with the growth in loans, say lenders.

For instance, average interest rate charged by Manappuram Finance touched 22% in the first half of this fiscal. The previous year, it stood well above 20%, says I Unnikrishnan, managing director.
Manappuram offers gold loans at a LTV of 75% while Muthoot does so at 61%, (down from 72% the previous year). Current average loan size at Rs38,000 is higher than the Rs25,000-33,000 range of the previous year. The ticket size is expected to rise further as Indians in the rural and semi-urban areas enjoy more spending power now than they had in the past.

One more positive is that unlike banks, gold loan companies don’t suffer the vexatious problem of non-performing assets (NPAs). If any gold loan shows signs of turning bad, lenders simply auction off the shiny collateral. “But people who usually come to us for loans pledge jewellery, for which they have emotional value. Thus, customers repay soon and redeem their gold,” says Unnikrishnan.

Manappuram’s 98% recovery record is a testimony to this fact.

As for the other 2% dodgy loans, gold loan companies usually give a short extension, if a well-meaning customer is not able to repay within the stipulated time. During the extension period, the customer has to continue paying interest. If the loan repayment is delayed beyond one-and-a-half years, lenders treat the pledged gold as an NPA, auction it off and recover their money.

Although the segment of gold loans is crowded with unorganised lenders like pawn brokers and affluent people in rural and semi-urban areas, organised players like banks are fast making inroads. For instance, public sector banks such as Indian Overseas Bank have a gold loan portfolio of Rs6,000-7,000 crore earmarked for rural people’s needs relating to agriculture. Besides, IOB also lends Rs700-800 crore to jewellers, says a senior official.

Under the priority sector lending scheme, however, public sector banks offer gold loans at discounted rates of interest, sometimes at as low as 4-5%. These loans have an LTV of 60-70%, says the official. In this instance, it’s a smile-smile situation for both lenders and borrowers.