Impact of Reserve Bank's tough norms for lending against gold jewellery by NBFCs

Share prices of top lenders of gold loan — Muthoot Finance and Manappuram Finance — dropped sharply on Thursday as the Reserve Bank of India (RBI) tightened rules for lending against gold jewellery by non-banking finance companies.

Muthoot Finance lost Rs.16.10 or 9.89 per cent to Rs.146.65 and Manappuram Finance Rs.8.40 or 18.54 per cent to Rs.36.90. The 52-week high of Muthoot Finance was Rs.198 and low Rs.148.55. For Manappuram Finance, the 52-week high was Rs.71 and low Rs.38.45.

The RBI on Wednesday stipulated that loan-to-value (LTV) ratio should not exceed 60 per cent for loans granted against the collateral of gold jewellery; percentage of gold loans to total assets to be disclosed in balance sheets; loans not to be granted against bullion, primary gold, gold coins; and Tier-I capital requirement raised to 12 per cent (10 per cent now) by April 1, 2014, for NBFCs engaged in lending against gold jewellery.

RBI stipulated these prudential measures “given the rapid pace of their business growth and the nature of their business model, which has inherent concentration risk and is exposed to adverse movement of gold prices.”

According to rating agency ICRA, a relatively small proportion of the lending happens at LTVs of 60 per cent or lower, and therefore, the disbursements volumes are bound to shrink. “There is lack of clarity on the computation of collateral value,” it said, adding, “the way the collateral value is computed would have a significant bearing on the profitability of a gold loan company.”

Further, lower LTVs could lower the lending yields of single-line gold loan companies (typically, lending yields decline as LTV drops), thereby impacting their return on equity. Moreover, the pressure on lending yields and disbursement volumes of gold loan companies would also increase because competing banks and diversified NBFCs would not have to follow the 60 per cent LTV norms. Meanwhile Muthoot Finance said that as on December 31, 2011, the company had a Tier-1 capital of 13.37 per cent. Further, it said that the company did not extend finance against bullion, primary gold and gold coins. The company finances only against security of household used jewellery. Of late, the industry has attracted lot of new entrants seeing the success of the existing players.

Muthoot Finance said that the RBI had taken these steps in order to regulate the risk especially “with respect to new entrants to the sector.”

Another rating agency Crisil said that the RBI's guidelines for the gold loan sector will significantly moderate the sector's growth and profitability over the next year. Business growth is likely to fall from 80 per cent to 20-25 per cent per annum and return on assets (RoA) is expected to fall from the high level of 4.5 per cent to 2.5-3 per cent.

However, Crisil believes that the RBI guidelines will have an overall positive impact on the sector over the long-term.