Finance companies' margins crash as gold temblor hits loans

MUMBAI: Gold is no more a safe asset. Nor are gold loans.

The risk associated with gold loans, which drew top-notch banks such as HDFC Bank, is now considerably higher as the precious metal's 18% crash from peak threatens defaults. 

The recent crash has also exposed lenders such as 
Manappuram FinanceBSE -1.59 %and Muthoot to thin margins that reduce the buffer they have against potential defaults as it lessens the eagerness of the borrower to repay. 

The intense competition of recent years made many companies compromise on key parameters such as the loan-to-value ratio, or the quantum of debt compared with the value of the precious metal used as collateral. Some have even come up with 'innovative' ways of assessing the value of gold by disregarding the making charges and losses while making an ornament. This adds at least 25% to the price of gold. 

"The current slide has exposed the vulnerability of loan portfolios that are disbursed primarily based on collateral values, with limited consideration for underlying cash flows," said Prakash Agarwal, director at India Ratings.

"High LTVs, together with largely bullet repayment structures (both principal and interest paid together) in the industry, leave limited cushion for correction in the value of security." 

To consider a simple example, If a company has lent Rs 75 against gold worth Rs 100 and the gold price falls by 25%, then the company may lose out because of the dip in the value of the collateral. 

Gold, the most sought-after asset of Indians in the last few years as they tried to beat stubbornly high inflation, has fallen 18% from its peak as global investors moved to other risky assets such as US and Japanese equities, which are climbing. The lending boom that followed during the 12 years of unbroken gains for the precious metal may lose its sheen if prices fall another 10-15%. 

gold prices could lead to increase in propensity to default on gold loans, affecting asset quality of companies," said Vibha Batra Analyst Icra. "Credit assessments of borrower are not done by gold companies, which may lead to increase in default." 

The size of the organised gold loan market is Rs 80 lakh crore. Gold loan companies were growing at 40% till 2011-12. The pace of growth has dropped to around 10% after the regulator introduced norms in February 2012, including a cap on LTV ratios for NBFC engaged in the gold loan business. RBI acted as it was concerned about the risk of a rampant rise in credit with gold as collateral. 

State Bank of IndiaBSE 2.18 % Chairman Pratip Chaudhuri said the bank will review its loan-to-value ratio for gold loans. For banks, RBI did not cap the LTV ratio. 

But industry officials say the worries are overdone, insisting they have enough collateral and their business model are sound. They say most of the loans are for about six months and are valued at less than Rs 1 lakh. Given that people are attached to the ornament, they revoke the pledge even if the prices fall.