The gold lending business once considered to be one of the safest financial assets has come under a cloud following the recent correction of gold prices in the international market. Gold prices have dropped 12% in the past fortnight to touch two-year lows. Such steep correction in gold prices is worrying investors as well as Non banking financial companies (NBFCs) specializing in gold loans. Industry experts believe that a further 10 per cent correction in gold prices in the near future could mean higher defaults and lower collateral realization impacting NBFCs badly.
The NBFCs have had a golden run in the past four to five years offering short term loans as high interest rates. Such was the impact of gold loans that the Reserve Bank of India (RBI) had to intervene to formulate Loan-to-value (LTV) guidelines at 60% of the gold value. With banks jumping in the fray as well, NBFCs were forced to take a liberal view on LTV value stretching it to as high as 80% in some cases. Experts believe that although high LTVs attracted more customers for NBFCs, such high LTVs along with its bullet repayment structures left limited cushion for gold price correction.
NBFCs face more heat compared to Banks: Financial experts believe that the recent gold correction is likely to have more negative impact on non banking financial companies (NBFCs) compared to banks. The underlying reason for high vulnerability of NBFCs is reduced cushion margins owing to strong competition. NBFCs have possibly more clients with weak credit profiles than banking institutions. According to a recent report by India Ratings & Research, south India based private sector banks are likely to be more impacted, primarily due to the higher proportion of gold loans in their books.
NBFCs Woes: The problem with non banking financial companies (NBFCs) is not limited to potential higher defaults but NBFCs with high gold loan portfolios are likely to witness liquidity pressures especially if lenders and banks become over cautious to the gold price correction. The common denominator for all these views is the constant correction of international gold prices. If prices reach a plateau, the impact may not be as severe.
Immediate Impact Vs Long Term Impact: Gold Finance companies believe that their business model is sustained to absorb any such gold pricing correction shocks. While it may be too early to dispute the claims of gold finance companies and NBFCs, a further 10 to 20% correction in gold pricing is likely to hurt the overall economic model of these companies. With rising prices of gold supporting the gold loans business in the past, the current correction is sure to bound overall profitability of most gold loan companies. The impact can be gauged from the fact that stocks of gold loan non-banking finance companies (NBFCs) have dropped as much as 10 per cent in the last 10 days. Gold loan major Manappuram Finance had also declared that the ongoing correction would mean it faced reversals of interest and it would book a one-time quarterly loss in the fourth quarter of 2012-13.
The recent gold correction has highlighted the potential flaws and vulnerability of NBFCs business model. This can be the best time for most NBFCs and banks relying heavily on gold loans to introspect and create a cushion for potential corrections in the future. Such exercise however may lose its focus if gold prices bounce back to their high levels in the coming weeks. NBFCs are also hoping that since average Indian household has a deep emotional connect with their gold jewelry, the number of defaults may not be as high as anticipated.