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Gold prices have soared 43% between 1 January and 7 August. (Mint)
Gold prices have soared 43% between 1 January and 7 August. (Mint)

Lenders wary of risks in gold loans

  • The primary reason for caution is the surge in gold prices
  • Lenders are unlikely to sanction beyond 80% of the value of the gold

Banks may not lend higher amounts against gold despite central bank permission on worries they will not be able to recover debt in case gold price crashes and the borrower defaults, three industry executives said.

The Reserve Bank of India (RBI) on Thursday increased the maximum loan to value (LTV) ratio for gold loans to 90% from 75% earlier, meaning customers can pledge gold with banks and get up to 90% of its value as loans, up from 75% so far. The scheme will be applicable till 31 March 2021.

The primary reason for the caution is the surge in gold prices: a decline could leave lenders with collateral worth less than the loan. The price of 10 grams of gold stood at 55,922 on Friday, as per MCX Gold Spot data sourced from Bloomberg.

Gold prices have soared 43% between 1 January and 7 August, allowing customers to get more money in gold loans.

An executive director at a bank said on condition of anonymity that lenders are unlikely to sanction beyond 80% of the value of the gold. This, he said, is because with an LTV of 90%, lenders will have a margin of just 10%, which is very thin at a time gold prices are volatile.

“Even if we give 90% of the gold’s value as loan, customers will be told that they have to top it up with more gold or repay some part of the loan for the bank to maintain its margin," said the banker cited above.

Experts believe that although gold loans will help meet the funding requirement of individuals and small businesses during the pandemic, a higher LTV carries risks as well.

“With gold prices at all-time highs, banks may be wary of increasing LTV all the way to 90%," said Krishnan Sitaraman, senior director, Crisil Ratings.

Sitaraman added that since the LTV relaxation is not applicable to NBFCs, some of the incremental demand witnessed by them may move to banks on account of higher value realization.

Despite expectations of banks seeing greater demand for gold loans, it remains to be seen if they can replicate the quick turnaround time of their non-bank peers in this segment.

Meanwhile, the Association of Gold Loan Companies (India), representing gold loan companies, has decided to approach the central bank, seeking parity in LTV ratio as their loans are still capped at 75%.

According to C.V.R. Rajendaran, chief executive, CSB Bank, while this move will help broaden the gold loan market, lenders will need to ensure that their valuation and risk management processes remain tight and robust.

Mint reported on 2 August that growing economic uncertainty has led to a surge in demand for gold loans.

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