Illustration for The Hiindu

The story so far: The Reserve Bank of India (RBI) earlier this month asked gold loan lenders to stick to regulatory norms while lending in a bid to tighten its grip over Non-Banking Financial Companies (NBFCs). The RBI has increased its scrutiny of NBFCs after it found certain NBFCs to be flouting regulatory norms. In March, the RBI banned IIFL Finance from issuing fresh gold loans after the firm was found violating lending norms.

What are the RBI’s gold loan norms?

The RBI stipulates lenders to comply with certain norms while lending money in lieu of gold. For instance, lenders are not allowed to lend any amount of money that is greater than 75% of the value of the gold that is submitted as collateral by the borrower. This is to ensure that banks have sufficient cushion to absorb any losses by selling the gold in case the borrower defaults on the loan.

Also read: Ensure gold loans are repaid and not renewed, banks tell branches

And in order to comply with income tax rules, the RBI also mandates that when a loan is disbursed to a borrower, no more than ₹20,000 can be disbursed in the form of cash; the remaining loan amount needs to be deposited in the borrower’s bank account. It also instructs lenders to conduct the auction of any gold (in case a borrower defaults) in a fair and transparent manner in locations that are accessible to the borrowers.

It is believed that the RBI is working on detailed guidelines for gold loans that lenders will have to follow.

Why does the RBI want to reinforce these norms now?

The RBI says it has found some NBFCs to be violating regulations linked to gold-based lending. IIFL Finance was disciplined in March for violating norms related to the size and form of loan disbursals, the evaluation and assaying of gold, the levying of charges, and irregularities in the auction process. For instance, the RBI found that there were loan-to-value irregularities in over two-thirds of defaulted accounts in the case of IIFL Finance.

It should be noted that NBFCs may want to increase the size of their loan book at an aggressive pace in an attempt to grow their business, and thus may be willing to offer loans of value that exceed 75% of the value of the underlying collateral. To do this, NBFCs may try to deliberately overestimate the value of the gold that the borrowers submit as collateral. It is thus not surprising that the RBI has raised concerns about the way in which gold is assayed and valued by NBFCs.

Lenders such as IIFL Finance were using internal assayers to evaluate the value and the purity of the gold offered as collateral by borrowers. This is in contrast to gold loans extended by banks wherein external assayers determine the value and purity of the gold. It should be noted that the gold loan portfolio of NBFCs has increased at an aggressive pace since the pandemic, growing over four fold from about ₹35,000 crore at the end of financial year 2020 to about ₹1,31,000 crore by the end of FY 2023.

The RBI may fear that such aggressive lending by NBFCs is happening in widespread violation of lending norms and that this could potentially cause systemic trouble in the future as the gold loan industry grows in size rapidly.

How will the RBI’s scrutiny affect NBFCs?

The NBFCs expect the RBI’s scrutiny of their lending practices to affect their growth and profitability. The RBI’s insistence that no more than ₹20,000 shall be disbursed as cash when a loan is approved, for instance, is expected to make NBFC gold loans less attractive.

The NBFCs have taken pride in offering emergency cash to borrowers at short notice unlike banks, particularly to those who are not part of the banking system and deal primarily in cash. Many NBFCs might also have to become less aggressive in their lending practices as the RBI enforces the loan-to-value rules more strictly.

It should be noted that the RBI had temporarily allowed lenders to make loans up to 90% of the value of the underlying gold collateral during the pandemic to help borrowers, and this also helped NBFCs expand their loan books aggressively.

Further, measures to make the auction process more transparent and accessible to borrowers could increase the cost of doing business for NBFCs and lead to higher borrowing rates for lenders. The RBI, on the other hand, may believe that its lending norms will make the gold loan business more sustainable and help avoid systemic risks in the long run.

Offering loans against gold has become popular in the recent years due to ease of process, lesser documentation, rapid availability of funding, and a variety of repayment options. File
| Photo Credit: Reuters

Banks have instructed their branches to ensure that gold loans availed of by customers are repaid and closed, and not renewed or upgraded.

Offering loans against gold has become popular in the recent years due to ease of process, lesser documentation, rapid availability of funding, and a variety of repayment options. Borrowers can pledge their gold as collateral and borrow the principal amount based on the gold’s purity, weight, and market rate. For non-agriculture gold loans, the Loan to Value is 75%.

The interest rates and tenure vary with respect to banks and there are various repayment options, including paying the interest and principal in equated monthly instalment (EMI), paying the interest as EMI and the principal at the end of the tenure and a bullet payment option where the principal and interest are paid at the end of loan tenure.

“There has been practice of evergreening – where fresh loans are given to borrowers to prevent an existing loan from turning bad. If the price of gold increases, borrowers who have not paid the interest on the gold loan properly, approach the bank, seek upgrading of the gold loan, and open a new loan account,” R.S. Dhuriyan, advocate, Indian Bank, said.

For instance, if the jewellery was valued at ₹1 lakh when the loan was availed, and the price increases to ₹1.50 lakh, the customer can seek to upgrade the loan for additional ₹50 lakh in a new loan account, he pointed out.

The RBI rules, however, do not allow evergreening, he added. Post Audit inspections of banks, RBI has told them to follow the rules, he said.

“I have a gold loan at a public sector bank in Pattabiram and went to make my interest repayment, the official at the bank said I cannot renew my gold loan after its tenure is over… A lot of customers have been paying interest and seeking renewal of the gold loan,” said Subha (name changed).Bank officials confirmed that branches were orally instructed not to renew existing gold loans.

Consumer activist T. Sadagopan said it was understandable that the regulator wanted to ensure that the existing gold loans were repaid, but banks should have been transparent in telling the customers that they should have repaid the gold loans.