Indian Gold Loan Industry: Who’ll take this Underpenetrated Market?

India, the world’s second-largest consumer of Gold worth $1.5 Trn, has a meager 3% of it pledged for loans. Is it a multi-billion-dollar market for the taking?

India’s tryst with Gold needs no introduction. Call it a shiny piece of jewelry, or a safe haven, or an emotional token… it’s always worth something. A country that amounts to about 25% of annual global gold demand holds over 25,000 tonnes of the shiny metal in its household kitties, which could be valued at more than Rs 110 Lakh Crore ($1.5 Trillion)!

And yet, Gold Loans (which are considered to be the most effective for small-scale borrowers in managing liquidity) have an organized market size of a mere Rs 3.45 Lakh Crore. While thrice a trillion is not ‘mere’ by any stretch of the imagination, here’s the catch... the gold loan market is a minuscule 3% of India’s total gold holdings!

So, is Gold Loan really an underpenetrated market? And if it indeed is, whose is this space - Banks or NBFCs or Moneylenders? Read on to make sense.

Indian Gold Loan Market - An Overview

First thing first, who prefers gold loans? And why?

According to the Economic Survey 2018-19, about 93% of India’s working population is in the unorganized sector (say, drivers, carpenters, electricians, plumbers, day laborers, etc.). Most of them don’t have a fixed income source, and when a crisis (like Covid) hits, they’re pretty much doomed! Also, small outlets (say, betel shops, hawkers & peddlers) find it really hard to get through in these fighting times.

In times of such liquidity crunch, Gold Loans come in handy for them. And the reason is a single-lettered word: ‘convenience’. You see, these small businesses and daily-wage workers earn their income usually in Cash. For most of them, it’s impossible to produce income proof, which is a prerequisite for obtaining loans. But Gold Loans are pretty simpler.

You don’t need ITRs & other income statements; just some basic address & identity proof would do. Pledge your gold, and your loan is approved quickly. Not much headache. And now you know why.

According to The World Gold Council, India’s organized gold loan market is poised to grow at a massive CAGR of 15.7% to reach Rs 4.62 Lakh Crore by 2022! And because this organized market is a mere 35% of the entire gold loan sector and 13% of the personal loan industry, there is no reason to not believe that this is a vast underpenetrated space.

Anyway, who’ll get to be the cream of the crop?

The Gold Loan War

Let’s consider the battle - Banks vs. NBFCs. (if you aren’t aware, NBFCs are just like banks, except that they don’t have access to low-cost fundings, i.e., deposits. They, basically, borrow & lend.)

Banks charge somewhere around 15% interest for gold loans, whereas NBFCs demand 20-25%. If we stopped here, you’d be prompted to think that, naturally, people prefer banks over NBFCs as they're cheaper. However, that’s not entirely the case.

You see, gold loans are small-ticket loans. Meaning, people borrow as little as Rs 30,000 for 2-3 months. If you were to do some calculations, you’d see that the additional 10% NBFCs charge more than banks, amounts to a little over Rs 300 only. And people are readily willing to forego this meager sum for the added convenience that NBFCs offer. So, what’s it about this convenience bit, you ask?

Banks have a lot of stuff going on, and gold loans aren’t exactly their first priority. They prefer big-ticket loans (like car loans, house loans, etc.). On the flip side, specialized NBFCs focus on gold loans and give personalized attention to customers. While NBFCs can process a gold loan in a matter of hours, banks usually take 3-4 days. And for a daily-wage worker whose family lives from hand to mouth, 3-4 days of bank visit means letting go of those many days of bread, isn’t it?

Thus, NBFCs that are open beyond the bank working hours & process the loans faster are preferred by a larger mass of gold loan takers.

Besides, as gold loans are small-ticket loans, you can only scale up by rolling out as many loans as you can. Owing to their ground-level reach & focus on sales, NBFCs flare better than banks.

Anyway, NBFCs have actually tapped into the psychology of Indians! Here's how...

Social Stigma against pledging Gold

Gold is a sentiment. A ring could be a gift from your better-half. A chain could have seen generations. And however needy you may be, you would not want people to discover that you’re putting your gold (read: relations) at stake to obtain money. Something of a taboo, you could say.

But when you visit a bank’s branch to obtain a loan against such gold ornaments and happen to meet one of your relatives or neighbors, you could have a tough time explaining to them what made you take such a decision.

Whereas in an NBFC specializing in gold loans, even if you come across any acquaintances in the branch, you don’t have to worry because you know they’ve come for the same purpose as you ;-) And this gives people an added sense of comfort because the social image is a big deal for Indians!

All of this provides NBFCs a clear advantage over Banks to cater to gold loan takers despite charging a little bit more. No wonder NBFCs have the lion’s share of 37% in the organized gold loan market, and 80% of gold loan takers from NBFCs are repeat customers due to their unique value proposition.

So, the next tussle is between NBFCs & Moneylenders. Although Moneylenders have an edge in terms of their reach & personal acquaintance with customers, they charge quite a hefty sum as interest, as high as 50-60%! And thus, they seem to be losing markets to the NBFCs. So, as it seems, NBFCs are all set to take this market.

But, you know what, the industry itself is somewhat cursed! Let us explain...

The LTV-Price Dilemma

Two interesting concepts are the core determinants of the gold loan industry: Loan-To-Value (LTV) ratio & Gold prices. For the neophytes, LTV states what portion of the collateral a person can borrow. Take it this way, suppose LTV is 75%... it basically means if you deposit gold worth Rs 100, you can obtain a loan of Rs 75. Simple as that.

Naturally, an ideal borrowing proposition would be high LTV and high gold prices. Because when the price of gold is rising, your gold will be worth more. And when LTV is high, you can obtain more loans for the same amount of gold pledged.

However, it’s not all that rosy.

Take the case of 2020, for instance. Lockdowns disrupted economic activity, and people were running short of money to make their ends meet. Meanwhile, gold prices were rising (~10%), which came in as a ray of hope amidst darkness. Small shopkeepers & workers relied on these rising gold prices and pledged their gold to obtain loans. It’s been a life-saver.

Also, in a bid to provide people with more liquidity, the RBI increased the LTV ratio for banks (not for NBFCs) from 75% to 90% in August 2020. That’s like the RBI permitting, deposit gold worth Rs 100 and get a loan of Rs 90 (while it was Rs 75 earlier).

And all of this lead to a surge in gold loans. For banks, it more than doubled to Rs 60,464 Crore. NBFCs like Manappuram and Muthoot too registered 15-24% growth in their gold loan portfolio during the period.

And it was all going fine until the second wave hits the economy &...

Gold loses its shine!

(Source: TradingView)

As you can notice, between August 2020 and March 2021, gold fell by a whopping ~20%! Know this thing that when gold prices fall, the amount of collateral with the bank/NBFC becomes less valuable, and the borrower would be required to either produce more gold to make up for the price-fall or repay the amount. And if not, the lender will be forced to sell off the collateral and recover losses to the extent possible.

Say you had borrowed Rs 90,000 by pledging gold worth Rs 1,00,000 (at 90% LTV). But, gold prices dropped (~20%). So, your pledged gold is now worth Rs 80,000. The lenders have knocked on your doors. But maybe you had already deposited all the gold you accumulated throughout life and don’t have more to shell out. And in times of crisis, probably you may not be in a position to repay the entire loan either.

So, you could technically default the loan and still be better off letting it go (as you have more money than the current value of your gold)! And most people did just this.

As a result, banks & NBFCs had to resort to the last option of selling-off the pledged gold. You won’t believe that Manappuram ended up auctioning Rs 404 Crore worth of gold between January-March 2021, whereas it had auctioned only Rs 8 Crore of gold in the nine months previous to that!

So now you know how aggressive loan disbursement & cyclicity of gold prices threaten the gold loan industry.

The bottom line

Besides, the gold loan NBFCs also face threats from fintech startups like Rupeek. As these startups follow a tech-savvy asset-light model, they can do better cost optimization than their offline peers. Also, changing consumer preferences towards Gold ETFs and the coming up of a Spot Gold Exchange could pose a threat to gold loan NBFCs (not soon, though).

It’s high time traditional players realize the increasing need to switch to a more tech-driven business model and adopt adequate risk management practices, should they wish to take this multi-billion dollar golden opportunity!