Loans – LTV curbs on gold loans don’t help
Recently, banks were permitted to increase the loan to value ratio (LTV) on gold loans for non-agricultural purposes to 90 per cent (from 75 per cent) till March next year. It is a welcome and, perhaps, overdue measure, not least because it acknowledges that the cap on LTV for gold loans imposed in 2012 is not etched in stone.
There is no bar on banks and NBFCs extending unsecured personal loans to their customers. They can finance a vehicle up to 80 per cent and more, even when the same sheds 30 per cent of its value in the very first year. But when it comes to a gold loan, where the underlying security is immune to depreciation and almost as liquid as cash, a borrower gets only 75 per cent. The rationale for a blanket cap on the LTV ratio for gold loans was never quite clear-cut.
As NBFCs were kept out of the purview of the relaxation, a section of the market interpreted the move as a setback for them. It is not so. NBFCs cater to a different class of customers compared to the banks, best described as “the top of the bottom of the pyramid.” Essentially, this class is neither destitute, nor well-off enough to interest banks. Besides, with greater last-mile reach and presence in unbanked areas, NBFCs serve customers in places where bank branches are absent.
Are banks up to the task?
All the same, it must be determined whether banks are in a position to deliver the full benefit of this relaxation to the target segment. After all, lending against gold at 90 per cent LTV is no easy task even in good times, let alone in volatile times such as now. It presupposes a finely tuned risk management system tailor-made for this one product that banks, whose attention is thinly spread over multiple products, are unlikely to have. In contrast, gold loans are the bread and butter for NBFCs, and they will likely have robust risk management practices honed over the years.
Appropriately, as if to underline the criticality of this aspect, no sooner was the relaxation announced that gold prices in India retreated from their all-time highs by over 10 per cent in a matter of days.
Moreover, if the objective of the measure is to mitigate the harsh economic fallout of the Covid-19 pandemic on marginal households and small businesses (whose credit requirements are clearly unmet by other channels), are banks in a position to step up to the plate? Can they service the demand from poorer classes for prompt credit delivered closer to their homes without being made to run around and forego wages for a day or two? It is worth highlighting that most such loans tend to be for relatively paltry amounts, say, ₹30,000- 40,000, borrowed for a month or two, by pledging 10-15 g of gold jewellery. These are not the typical bank customers.
The risk element
In allowing preferential treatment for banks, regulators would have noted that banks deal in many products, with gold loans forming only a small part of their overall loan book, automatically checking the risk element. However, the case of gold-loan focussed NBFCs could also be considered as their specialised experience in the field ensures they are well-placed to deal with the attendant risk.
The fact is, NBFCs exist because gaps in the banking system leave out significant sections of people engaged in the informal economy. They address this constituency by acquiring specialised knowledge gained through focussed attention over the years, which in turn enables innovations to contain the inherent risks in catering to this segment.
From the perspective of a regulator charged with prudence and safeguarding the system against excessive risk-taking, the objective may also be met by prescribing suitably higher risk weights on the higher LTV gold loans. This would ensure that only well-capitalised NBFCs who are capable of absorbing the shocks that arise enter the fray.
LTV cap needs a relook
It is well-known that India has the largest hoard of privately-owned gold, with the affinity for gold and its ownership cutting across the rich-poor divide. Ideally, our policies should enable the poor to monetise their gold assets better by doing away with the LTV cap, and allowing well-capitalised NBFCs with prudential risk management practices and proven track records to introduce products offering higher LTV of 90 per cent or even more. The incentive of higher loan amount on their meagre gold holdings will avert marginal borrowers from being lured by informal financiers and nudge them towards the formal sector.
Would this make them vulnerable to excessive borrowings as to run the risk of forfeiting their jewellery? Our experience suggests otherwise. For instance, the recent run-up in gold prices has actually deflated the portfolio-level LTV for gold-loan majors to well below 60 per cent these days. It may be said that gold-loan customers tend to be conscious of their cash flows and of the need to redeem their precious jewellery, and therefore borrow accordingly.
An artificial cap on the LTV tilts the playing field in favour of unorganised lenders. It denies established NBFC players a legitimate opportunity to capitalise on their experience, higher capital adequacy and superior risk management practices. In fact, removing the cap on gold-loan LTV may even spark off the next wave of innovations in the industry, for instance by introducing credit risk assessment into gold loan appraisal, or novel and more efficient risk management practices.
The exclusion of NBFCs from the increase in LTV is unlikely to hamper their business prospects. But it will certainly impact their marginal borrowers who would have been keener than most to avail themselves of such a benefit. By restricting the benefit of the relaxation to the bank customers only, a vulnerable section of the population is effectively punished. That, surely, would not have been the intention!
The writer is MD & CEO of Manappuram Finance Ltd. Views are personal