CMR SCHOOL OF LEGAL STUDIES

BENGALURU

Report Analysis
Of
Working Group to Study the Issues Related to Gold Imports
and Gold Loans NBFCs in India

SUBMITTED TO: Prof. Shivani Rajesh

SUBMITTED BY: Snigdh Shikhar Singh
PROGRAM: LLM

Table of Content
S. No. Topics Page No.
1 Introduction 2
2 Significant Issues 2-3
raised by the
Working Group
3 Key suggestions of 3-4
the Working
Group on Micro
Issues
4 Appraisal and 4-5
Criticism of the
Report
5 Conclusion 6-7
Introduction
The Working Group of RBI was assigned with the task of studying whether large gold
imports of India are a threat to external stability. The Working Group was also asked,
among other stuff, to review the recent tendencies in precious metal loans extended
by huge gold mortgage NBFCs and find whether there are any systemic balance
issues that arise from the interconnectedness between banking institutions and
precious metal loans NBFCs. The Working Group followed an eclectic approach to
address the conditions of reference designated by undertaking specialized exercises
to study the partnership among various related financial variables; and to conduct
surveys through intense dialogue with all the stakeholders to firm up related views.
Existing regulations related to NBFCs-Non-Deposit taking (ND) – Systemically
Essential (SI) sector were examined and suggestions were offered.
India is one of the biggest markets for gold and gold loan. According to World Gold
Council, India accounts for 10% of total world gold stock and is world’s largest gold
consumer1. Indian investment in gold is motivated by social, cultural and economic
reasons. For Indians, gold is not just a commodity, but an auspicious metal that they
buy for various purposes on different occasions. There has always been a high
demand for gold in India, irrespective of prices. During 2001- 2012, the annual
demand for gold remained relatively stable at around 700 to 900 tonnes despite
constant rise in prices.
Over the last few decades, there has been a considerable shift in the scenario of the
Indian gold loan market, with the emergence of formal financial institutions
providing loans against gold as collateral. These formal financial institutions consist
of banks and other private financial institutions such as NBFCs who cater to the
financial needs of low-income households at better cost. On the other hand, informal
gold loan market comprising of pawn brokers and private money lenders have been
in existence for over centuries that perhaps explains the extremely skewed market
share between the unorganized and the organized gold loan sector (75:25). Gold loan
is an important source of credit for low-income households as loans against gold as
collateral are easily available. Compared to other sources of credit available to low-
income households such as loans from MFI, loans from SHGs or community based
borrowing; gold loans are disbursed more quickly with minimal procedural
requirements. The consumer friendly features of the gold loan market distinguish
itself from other sources of credit, thus making gold loan products extremely popular
and reliable.

Significant Issues raised by the Working Group

There were two issues dealt by the Working Group namely Micro and Macro
Issues.

 Macro Issues
Large gold imports are adversely impacting the existing account deficit. There is a
need to moderate the demand for gold imports, as ensuring external sector’s
stability is critical. It is necessary to discover that demand for gold in India isn’t
 strictly amenable to plan changes and in addition is price inelastic because of
varied reasons. Banks’ function in canalising gold imports is certainly important,
but provides been declining through the years. There is usually scope for
reviewing the current incentives available for banks to deal with gold imports. In
the context of growing demand for gold, it is critical to ensure real returns to
traders through various cost savings products, to ensure that their attention could
be diverted from gold, at least, partly. There exists a dependence on banks to
introduce brand-new gold-backed financial loans that may decrease or postpone
the demand for gold imports. Investors’ awareness and education is important in
the context of channelizing the expense to gold-backed financial products. The
Working Group believes that offering true rate of return to investors through
alternate instruments holds the key to reducing the excessive demand for gold. In
the meantime, there is also a have to increase monetisation of idle gold stocks in
the economy for productive purposes. Encouraging loans against the security of
gold for successful purposes could be a real way to get this done.

 Micro Issues

The financial performance of the gold loans NBFCs and the existing degree of
their borrowings from the bank operating system aren’t of critical concern. There
is apparently no instant systemic implications with regards to domestic financial
stability because of the interconnectedness of gold loans NBFCs and bank
operating system. Banks and NBFCs may continue to deliver gold jewellery loans,
which monetise the idle gold in the country. The gold loan market has grown well
in recent years. It is time for consolidation of the functions of the gold mortgage
NBFCs. The gold loan NBFCs need to transform themselves into establishments
free of complaints, have correct auction and documentation techniques, with
rationalised interest structure and also have a branch network that’s fully secure
and safe and sound.

Key suggestions of the Working Group on Micro Issues

 The rapid growth of the assets, borrowings and branch network of gold loan
NBFCs need to be monitored continuously.
 Need to reduce the gold loan NBFCs’ heavy borrowings from the banking system
so as to reduce their interconnectedness with the formal financial system
gradually.
 Need to review the current stipulations pertaining to raising of resources through
non-convertible debentures (NCDs) by gold loan NBFCs. Declining capital
adequacy ratio – Need to improve the capital of gold loan NBFCs.
 There is a need for monitoring transactions between gold loan NBFCs and
unincorporated bodies. Though leverage of the gold loan NBFCs is not a cause for
concern at the present juncture, going forward, there is a need for improving
owned funds of the NBFCs. The exemption available to secured debentures from
the definition of ‘deposit’ may be reviewed.
 There is a need to thoroughly review the operational practices followed by gold
loans NBFCs. Institution of a customer complaints and grievances redressal
system by gold loans NBFCs is important.
 There is a need to ensure transparent communication of loan terms by gold loans
NBFCs.
 Need to review the auction procedures followed by gold loans NBFCs. Location of
auctions should be the same Taluka where the borrower is located.
 Post-auction safeguards should be followed by gold loans NBFCs. Better
disclosure standards need to be followed by gold loans NBFCs.
 Monitoring the implementation of the Fair Practices Code is necessary and
standard documentation to be followed by gold loans NBFCs needs to be ensured.
 Use of PAN Card for large gold loan transactions is advised and payment through
cheque for large gold loan transactions may be tried.
 As of now, there is no case for conceding level playing field for the gold loan
NBFCs with the banks.
 There is a case for reviewing the extant ‘loan to value ratio’, however, a well-
defined and standardised concept of the term ‘value’ is necessary.
 Unbridled growth of branches by large gold loan NBFCs needs to be moderated.
 There is a need for an ombudsman to address the grievances of gold loan
borrowers and rationalisation of interest rate structure by gold loans NBFCs is
advised.
 Some gold loan NBFCs have been raising public deposits surreptitiously through
unincorporated bodies raising concerns.

Appraisal and Criticism of the Report

 The most critical aspect in the report is that it seeks to review the existing clamp
on the maximum that gold loan firms can lend against the value of physical gold
under deposit. This would mark a flip flop within a year of putting a ceiling of 60
per cent on loan to value or LTV ratio, which hit gold loan firms. The report refers
to a higher LTV ratio followed by commercial banks related to their gold loan
portfolio which is in the 70-75 per cent range. If indeed this ratio is raised for gold
loan NBFCs, they can lend more for the same quantum of gold held by a
borrower, which means higher outstanding and more earning.
 The report points out that the asset quality and NPAs as per cent of total credit
exposure and capital adequacy of gold loan NBFCs are not a cause for concern at
present. But it added that capital adequacy ratio of gold loan NBFCs has
witnessed a continuous declining trend over the past few years and the ratio for
gold loan NBFCs was also lower than that of other NBFCs and henceforth they
need to improve their capital base.
 The working group found out that gold loan NBFC’s dependence on the banking
sector as a source of funding witnessed an increase during the last five years and
bank borrowings were the biggest source of funds for them. Gold loan NBFCs
should gradually reduce their dependence on the bank finance so as to bring
down the interconnectedness with the formal financial system. But it also added
 that there is no credit concentration risk for banks as yet given that such loans
form only a miniscule portion of total liabilities of banks.
 The working group found borrowers complaining about the lack of basic
amenities at the branches which could possibly endanger the safety of the gold
pledged with the NBFCs. It recognised the need for a minimum standard and has
suggested the requirement of an approval for the new branches an NBFC (which
has already expanded beyond 1,000 branches) can open in a year. It has also
proposed a ceiling on the number of branches a NBFC can open in a year. This
was a negative for Muthoot and Manappuram.
 The majority of the complaints related to gold loan NBFCs relate to the charging
of interest. The report has called for an interest cap on the loans disbursed by
such NBFCs and has suggested that the gold loans NBFCs may consider adoption
of an interest rate linked to a benchmark rate like State Bank of India’s maximum
advance rate. Alternatively, the RBI can also consider imposing a cap on the
interest rates to be charged on gold loans by the NBFCs. This could be a short
term pain but could help such NBFCs avoiding a situation which hit the
microfinance sector due to lack of clear regulations.
 The report highlights an issue which has been under the scanner of the RBI
wherein gold loan NBFCs float unincorporated sister concerns to raise public
deposits, which is not permitted by the regulator. Therein, public deposits are
raised and diverted to the registered gold loan NBFCs.
 It also said that there is a need to review the current stipulations pertaining to
raising resources through NCDs as some gold loan NBFCs have been
circumventing it and mobilising funds bearing ticket size of as less as Rs 5,000,
which is tantamount to raising surrogate deposits. If the present exemption
available to such NBFCs is removed or a basic slab of individual contribution to
NCD is prescribed for a minimum investment of Rs 10 lakh or so for private
placement, it will deter retail investors to subscribe and confine private
placements of NCDs by gold loans NBFCs to institutions and HNIs.
 Auction of gold in case of loan default is presently around 1 to 2 per cent of total
loan size and boards of gold loan NBFCs need to adopt specific guidelines on
auctioning of jewelleries based on broad regulatory prescriptions and a revised
Fair Practices Code. It may be stipulated that the pledged gold ornaments should
be auctioned off at a price closure to the prevailing rate in the market on the day
of auction, so that the borrowers’ interests are protected. The report says such
auctions should ideally be in the same location of the borrower and if not
preferably in the Taluka Head Quarters to offer another opportunity to the
borrower to redeem the gold pledged.
 The findings of the working group reveal that a sudden drop in gold price to the
tune of 30 to 40 per cent, causing financial distress to the gold loan NBFCs, is a
remote possibility. Even a likelihood of decline in gold price of 10 per cent or
above is in the range of 3.3 per cent to 14.6 per cent during one month to six
month period. It added that the existing LTV ratio provides sufficient cover for a
moderate price fall.
 Profitability of gold loan NBFCs has been much above than that of the NBFCs as a
sector over the last four years. The return on assets of gold loan NBFCs was at 4.6
per cent as against the return on assets of all NBFCs pegged at 1.8 per cent.
 Return on equity of the gold loan NBFCs has also been consistently higher,
displaying better prospects for resource mobilisation of these companies vis-à-vis
rest of NBFCs.

Conclusion

 Gold loans have a causal effect on gold imports substantiating the emergence of a
liquidity motive for holding gold. International gold prices and exchange rate
significantly and positively affect the gold prices in India.
 Increase in gold prices appears to be one factor that increase the gold loans
outstanding and increase in gold loans extended by banks and NBFCs does not
impact considerably the gold prices in India.
 Based on empirical analysis of volatility in gold cost, it really is difficult to
estimate future prices of gold.
 Going by days gone by trends, a sharp unexpected drop in gold price by 30 to 40
per cent is a remote possibility causing financial distress to the gold loan NBFCs.
 The extant loan to value ratio (LTV) ratio should provide a reasonable risk cover
in case the gold prices fall by 10 %.
 Asset quality, NPAs according to cent of total credit publicity and Capital
adequacy of gold loan NBFCs are not a cause for concern at present.
 The sources of funds of gold loan NBFCs do not appear to be an immediate cause
of concern giving rise to concentration credit risk and the striking growth of gold
loan NBFCs business warrant that their functions could be closely monitored.
 Some gold mortgage NBFCs have already been raising open public deposits
surreptitiously through unincorporated bodies raising concerns and banking
sector’s accessible publicity in the type of their individual gold loans appears
small and might not exactly possess any critical repercussions designed for the
balance of the banking sector at the moment.
 Possibility of volatility in gold prices impacting the gold mortgage market is low
and gold loans NBFCs are put through prudential reporting and regulations
requirements.
 Gold loans NBFCs are doing a socially useful function and that provides a strong
rationale for a careful regulation of the activities of these NBFCs and the recent
slew of regulatory measures taken by RBI on the functioning of the gold loan
NBFCs may be continued to ensure a healthy growth of the sector in the medium
and very long term.
 Gold loan was mostly acquired for consumption soothing purposes; however, it
was also observed that the source of loan varied according to the purpose for
acquiring loan. Lastly, we explored reasons as to why people buy gold and the
results suggest that people view gold as an insurance that helps in safeguarding
their future against uncertainty. Gold loans in India have been in existence for
centuries now in the form of pawn shops delivering quick and easy access to loans
against gold as collateral. Until a couple of decades ago, gold loans were delivered
only through the unorganised sector by private money lenders and pawn brokers.
However, with the entrance of formal financial institutions in the gold loan
sector, the market dynamics changed completely as they introduced innovative
gold loan products at cheaper costs and better customer service. While it is true
that high demand for gold burdens the current account balance by increasing
deficit, the fact that gold is the most valued asset among Indians, cannot be
neglected either. Over the years, gold has become an inseparable part of the
Indian society, as it not just holds an emotional value but is also used for various
other financial purposes like savings, investment and insurance. This fact is more
so true in the context of rural India, which accounts for 65% of the total gold
stock9. Therefore, curbing demand for gold and gold loans should be
complemented by introducing innovative financial products that can act as a
substitute for gold loans. Gold loans are more than just a conduit for credit- they
also act as a delivery mechanism that helps progress the lives of some of the
poorest households and policymakers needs to be sensitive to these realities.