India’s gold loan institutions are systemic risk bearers

RBI has now comes with more hard measures to check the gold loans by Non Banking Financial Companies. In a fresh notice the central bank has instructed the NBFCs no to give loans above 60% of the gold value. The new direction from RBI will definitely check gold loan given by these institutions.

                The RBI’s fresh directive is to ensure the safety of the financial institutions engaged in the market. There is strong perception in the minds of the market observers that Gold price may come down once the economic problems in the west subside.

                A decline in gold price may encourage the borrowers to default. On the one side, the value of their loan in the banks may come down. On the other, the burden of their loans will go up. Similarly once, gold price starts falling, the borrowers may wait for the time to be profitable for them to default. Such price fall expectations may lead to mass default.

                If the gold value becomes lower than the loan value due to gold price fall, the borrowers are asked to keep additional gold to the banker, as per norms. But, the probability of that event is very low in a real world situation.

                Falling gold price is a probability once Dollar and Euro gets stronger. In such an environment, the gold loan NBFCs in the country may face heavy default risk. An interesting feature of the country’s gold loan market is that two NBFCs – Muthoot and Manappuram have a collective share of more than 50%. They have defeated the whole behemoth commercial banking system in the promotion of the product. The marketing strategy of many other gold loan NBFCs is also very aggressive as many of them give almost 80% of the gold value as loan.  The RBI, a couple of months back directed the gold loan NBFCs not to receive public deposits. Indeed, the central bank is tightening the screws against the occurrence of a likely financial catastrophe.