The country’s banking regulator has tightened the non-banking finance company (NBFC) norms for lending against gold, which will affect the growth rate of gold loan companies like PE-backed Muthoot Finance and Manappuram Finance.

The Reserve Bank of India has asked all NBFCs to maintain a Loan-to-Value (LTV) ratio not exceeding 60 per cent for loans granted against the collateral of gold jewellery and disclose in their balance sheets the percentage of such loans to their total assets. The RBI has also raised the minimum tier I capital limit for NBFCs focused on gold loan (gold loan being more than half of the financial assets), from 10 per cent to 12 per cent. This has to be achieved by April 1, 2014. The central bank has also asked NBFCs not to grant any advance against bullion/primary gold and gold coins.

Consequently, stock prices of gold loan companies crash-landed on Thursday. Muthoot Finance scrip crashed to a 52-week low before making up partly to end the day at Rs 146.65 a share, down 10 per cent on the BSE in a flat Mumbai market. Manappuram Finance also hit its one-year low before marginally moving up and last traded at Rs 36.9 a share, down over 18 per cent.

In a statement, Muthoot Finance said, “Of late, the industry has attracted a lot of new entrants seeing the success of the existing players. We feel that the RBI has taken these steps in order to regulate the risk, especially with respect to new entrants to the sector, who may not be aware of the various nuances of the business, and also to strengthen the existing companies. The steps taken with respect to capital adequacy and LTV should be seen as steps to strengthen the sector with robust operating practices and risk control measures.”

Those who have built or are building their presence in the gold loan space beyond their existing core businesses include public-listed micro lender SKS Microfinance and KKR & IFC-backed Magma Fincorp, among others.

According to the regulator, these norms have been set as a prudential measure, given the rapid pace of business growth and the nature of the business model, which have inherent concentration risk and expose a firm to adverse movement of gold prices.

RBI has also noted that NBFCs, predominantly engaged in lending against the collateral of gold jewellery, have recorded significant growth in recent years – in terms of balance sheet, as well as physical presence. “This, in turn, has led to their increased dependence on public funds including bank finance and non-convertible debentures issued to retail investors,” it has stated.

This essentially implies if the value of the jewellery is Rs 1 lakh, NBFCs can extend only Rs 60,000 as loan. Currently, most gold loan companies have a much higher LTV.

Some time ago, in an interview with VCCircle, George Alexander Muthoot, MD of Muthoot Finance, had said that his firm had LTV of 71 per cent.

But the company has cut it down since. At present, its gold loan assets under management is around Rs 24,000 crore ($4.8 billion) and the value of jewellery with the company is more than Rs 40,000 crore ($8 billion) approximately.

“Hence our LTV is below 60 per cent. As a matter of abundant caution, we had been progressively reducing our lending rate per gram as a risk management measure, seeing the volatility in the gold prices during the last couple of months,” Muthoot Finance said.

Manappuram Finance disclosed its capital adequacy ratio as of December 31, 2011 stood at 18.37 per cent, or much above the minimum required under the new norms. However, its LTV ratio is marginally above the ceiling set by the banking regulator. The company said its average LTV is at 66 per cent which will come down as per the requirements of RBI.

"With the proposed consolidation of the company's branch network and consequent optimisation of  operating expenses at the branch level, the impact of the reduction in LTV on yield will be mitigated," the company said.

The move will certainly decelerate the growth rate of the gold loans business, which has been moving up at a breakneck pace, thanks to the spiralling price of the yellow metal. However, it can still turn out to be a positive move from an industry perspective, as it will partly derisk the business from the sharp volatility of gold price.

Gold loan business is estimated to have doubled over the past two years, boosted by over 30 per cent rise in gold prices in 2011. Although no one is predicting a crash in prices, the new LTV norms sets a sufficient hedge against companies going under in such a scenario.

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