Central Bank increases Loan to Value ratio, Gold gets more power, Banks emerge winner

Central Reserve Bank Gold Loan and Banking Policy

The Reserve Bank of India’s (RBI) decision to increase the loan-to-value ratio (LTV) for banks from an earlier 75 per cent to 90, is a music to the ears of many, especially those who have  a good exposure to gold and gold related investments. The decision was made by the RBI Governor Shaktikanta Das led Monetary Policy Committee (MPC) and was announced by the Governor on Thursday. This relaxation is available till 31 March 2020.

The loan-to-value ratio is a term which determines the loan extended to a customer by the banks or financial institutions against the value of the asset which is mortgaged. In this case it is gold.As per the existing guidelines, banks are allowed to sanction loans not exceeding 75 per cent of the value of gold ornaments and jewellery, pledged by the customer.

The announcement assumes importance at a time when there is a financial stress all across the country in the wake of coronavirus pandemic. In India alone, over 20 lakh people have been affected with this disease while over 40,000 have succumbed to it, till now.

This move is aimed at helping people in distress, especially households.

While the economic activity has started to recover from the lows of April-May months, the problem is far from over as cases continue to rise at alarming proportions. This rise in numbers hasonce again forced fresh lockdowns.If the RBI’s observation are any indication to what lies ahead, liquidity could be a problem, going forward.

Timing of the move:

Pledging of gold for loans is a phenomenon more prevalent in Southern India. In North India, it is still not a runaway business. The timing of this move could not have been better as the bullion prices are now increasing rapidly. While the Covid-19 impact has been very severe, resulting in large scale job losses and salary cuts and creating financial stress for an average household, a higher bargain for the pledged gold,augurs well.

This also means that the people may not be forced to sell their gold for a higher loan value in times of need. The people will also be encouraged to go to the formal channels like banks to take loans instead of approaching money lenders. This loan is popular among the people with short term financial needs.

This will also help MSMEs and farmers who could approach a bank for working capital loans.

The advantage of a gold loan is that one can pledge it any number of times. So, a person can take a loan any number of times on the same item unlike personal loans where the banks scrutinise the paying capacity of the loan seeker.

This is also one of quickest ways to avail loans. Many banks and financial institutions now claim to process gold loans in matter of a couple of hours or even less time.

It is also believed in some quarters that the demand for gold will further increase as uncertainties around the economy may not go away anytime soon. People with disposable incomes have been preferring investments in gold and silver to hedge their losses. They may invest in gold and pledge it in the times of need.

What it means to businesses!

Increasing the LTV ratio is also expected to create a demand in the system. It will also help in the growth of this segment and enable lenders to increase their gold loan books. Another important aspect is that this asset class is one of the safest mortgage options, something that banks readily take. With rising prices, it remains a prized asset for banks to have as a security for the loans they disburse. This will also increase competition in the market which will ultimately benefit the customers.  

A media report says that an estimated 22,000 – 25,000 tonnes of gold is lying idle in the Indian households and a lion share (around 65 per cent) is possessed by the people in rural India. The same reports says that only 1.2 per cent of this is pledged as collateral. This leaves huge potential for this segment to grow.

NBFCs and gold financing companies may find themselves at a loss as this relaxation has not been extended to them. They fear that some of their business may now shift towards the banks. The LTV ratio for NBFCs is capped at 75 per cent.

Challenges

 From the customer standpoint, the loan amount could still differ from one lenderto another and there is a risk that the full value of the gold may not be realised. While, the jewellery may have a book value, there is also a sentimental value attached to it. The bank can liquidate it on non-payment of loan.

 For banks, one of the challenges could be on the liquidity front asthey will now be required to give a higher amount for the same quantity of gold. Moreover, the gold rates have seen a significant uptick since March and have risen by over 30 per cent. Thisprecious metalwillcontinue to become dearer in the medium term,forcing higher cash outgoes for the banks.

The banks will also be exposed to a greater risk when the prices soften and see a correction. This could lead to defaults. A fall in gold price could disturb the loan-to-value-ratio at which the loans were disbursed by the bank.

The banks will also be required to tighten their valuation and risk management processes. It is a no brainer that the banks’ workload is going to increase now as any lapse would lead to the growth in their NPAs.

This decision was taken in the 24th meeting of the MPC.Among other key decisions, the committee decided to keep the key policy rates unchanged. In a unanimous decision, the committee decided to retain the repo rate at 4 per cent while the reverse repo rate at 3.35 per cent.

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