The RBI working group’s draft proposals related to gold loans and import of the yellow metal have assuaged concerns that gold loan firms are sitting on a ticking time bomb due to their frenetic growth and also suggested measures to boost lending including that by PE-backed gold loan NBFCs.
While the stock market investors continue to push up share prices of Muthoot Finance and Manappuram Finance, here’s a quick look at ten points of relevance for the gold loan companies, including a few less appetising ones which could yet affect their growth.
Push up loan to value or LTV ratio
The most critical aspect in the draft proposals is that it seeks to review the existing clamp on the maximum that gold loan firms can lend against the value of physical gold under deposit. This would mark a flip flop within a year of putting a ceiling of 60 per cent on LTV ratio, which hit gold loan firms. The draft refers to a higher LTV ratio followed by commercial banks related to their gold loan portfolio which is in the 70-75 per cent range. If indeed this ratio is raised for gold loan NBFCs, they can lend more for the same quantum of gold held by a borrower, which means higher outstanding and more earning.
NPAs comfortable, but need to strengthen capital adequacy
The report points out that the asset quality and NPAs as per cent of total credit exposure and capital adequacy of gold loan NBFCs are not a cause for concern at present. But it added that capital adequacy ratio of gold loan NBFCs has witnessed a continuous declining trend over the past few years and the ratio for gold loan NBFCs was also lower than that of other NBFCs and henceforth they need to improve their capital base.
Need to check dependence on banks for funding
The working group found out that gold loan NBFC’s dependence on the banking sector as a source of funding witnessed an increase during the last five years and bank borrowings were the biggest source of funds for them. Gold loan NBFCs should gradually reduce their dependence on the bank finance so as to bring down the interconnectedness with the formal financial system. But it also added that there is no credit concentration risk for banks as yet given that such loans form only a miniscule portion of total liabilities of banks.
Large gold loan NBFCs to rein in branch growth
The working group found borrowers complaining about the lack of basic amenities at the branches which could possibly endanger the safety of the gold pledged with the NBFCs. It recognised the need for a minimum standard and has suggested the requirement of an approval for the new branches an NBFC (which has already expanded beyond 1,000 branches) can open in a year. It has also proposed a ceiling on the number of branches a NBFC can open in a year. This is a negative for Muthoot and Manappuram as both have over 3,000 branches and are looking to add more to spread their base beyond South India.
Rationalisation of interest rate structure
The majority of the complaints related to gold loan NBFCs relate to the charging of interest. The report has called for an interest cap on the loans disbursed by such NBFCs and has suggested that the gold loans NBFCs may consider adoption of an interest rate linked to a benchmark rate like State Bank of India’s maximum advance rate. Alternatively, the RBI can also consider imposing a cap on the interest rates to be charged on gold loans by the NBFCs. This could be a short term pain but could help such NBFCs avoiding a situation which hit the microfinance sector due to lack of clear regulations.
Curb gold loan NBFCs from raising public deposits, review NCDs and ‘deposit’
The report highlights an issue which has been under the scanner of the RBI wherein gold loan NBFCs float unincorporated sister concerns to raise public deposits, which is not permitted by the regulator. Therein, public deposits are raised and diverted to the registered gold loan NBFCs.
It also said that there is a need to review the current stipulations pertaining to raising resources through NCDs as some gold loan NBFCs have been circumventing it and mobilising funds bearing ticket size of as less as Rs 5,000, which is tantamount to raising surrogate deposits. If the present exemption available to such NBFCs is removed or a basic slab of individual contribution to NCD is prescribed for a minimum investment of Rs 10 lakh or so for private placement, it will deter retail investors to subscribe and confine private placements of NCDs by gold loans NBFCs to institutions and HNIs.
Concurrently it has also asked for review and withdrawal of the exemption available to secured debentures and subordinated debt from the definition of “deposit”.
Need to review the auction procedure
Auction of gold in case of loan default is presently around 1 to 2 per cent of total loan size and boards of gold loan NBFCs need to adopt specific guidelines on auctioning of jewelleries based on broad regulatory prescriptions and a revised Fair Practices Code. It may be stipulated that the pledged gold ornaments should be auctioned off at a price closure to the prevailing rate in the market on the day of auction, so that the borrowers’ interests are protected. The report says such auctions should ideally be in the same location of the borrower and if not preferably in the Taluka Head Quarters to offer another opportunity to the borrower to redeem the gold pledged.
The findings of the working group reveal that a sudden drop in gold price to the tune of 30 to 40 per cent, causing financial distress to the gold loan NBFCs, is a remote possibility. Even a likelihood of decline in gold price of 10 per cent or above is in the range of 3.3 per cent to 14.6 per cent during one month to six month period. It added that the existing LTV ratio provides sufficient cover for a moderate price fall.
Growth trends in gold loan NBFCs
Gold loan NBFCs continue to play second fiddle to banks which account for around 70 per cent of such loans at present. However, the report highlights how such NBFCs have been leading industry growth with CAGR of almost 100 per cent as against industry average of around 65 per cent. Although NBFCs growth in such loans has skid after hitting a high in FY10 and has fallen over the next two consecutive fiscals (when banks gold loan growth rate has accelerated) in FY12 it was still higher than that of the banks.
Profitability and return on assets
Profitability of gold loan NBFCs has been much above than that of the NBFCs as a sector over the last four years. As at end-March 2012, the return on assets of gold loan NBFCs was at 4.6 per cent as against the return on assets of all NBFCs pegged at 1.8 per cent. Return on equity of the gold loan NBFCs has also been consistently higher, displaying better prospects for resource mobilisation of these companies vis-à-vis rest of NBFCs.
(Edited by Prem Udayabhanu)