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Over the last decade, the rise of NBFCs that focus on gold loans has been well-chronicled by the media. They are now widely acknowledged as being instrumental in formalising an activity hitherto the preserve of shadowy moneylenders and pawnbrokers operating away from regulatory oversight. Banks were largely uninterested in gold loans, giving a free run to the unorganised players until their dominance was challenged by gold loan NBFCs. But these days, we see the private and public sector banks make a vigorous play for gold loans.

According to the RBI’s latest monthly data on sectoral deployment of bank credit, the gold loans portfolio of banks stood at ₹62,926 crore as of August 27, 2021. Compared to ₹37,860 crore a year ago, that is a jump of 66 per cent in one year. Go further back and, in August 2019, it stood at just ₹26,542 crore. Clearly, banks in India are now a rising force in the gold loan space.

Favourable treatment

What explains the spectacular growth in the gold loans portfolio of the banking sector over the last one year? There’s no doubt that favourable treatment by the regulators was an important factor.

Early in August 2020, the RBI had announced an increase in the loan-to-value ratio on gold loans given by banks (from 75 per cent to 90 per cent) up to March 31, 2021, to provide relief to borrowers affected by the pandemic. That relaxation was not extended to NBFCs, and it opened up a limited-time window of competitive advantage for banks that was duly exploited by them.

Another reason was that sporadic lockdowns had a milder impact on the organised sector, whose digital reach and capabilities are much greater. Corporate India, for instance, reported higher-than-expected profits in the lockdown-affected quarters even without gain in volumes, thanks largely to the cost cutting enabled by their digital reach.

Oganised sector

Banks deal predominantly with customers from the organised sector, who were relatively less impacted, but nevertheless found access to regular loans harder to come by. On the other hand, the unorganised sector bore the pain much more and for an extended period. Lacking scale and a digital backing, many were forced to shut shop. A significant section of borrowers of the gold loan NBFCs belong to this segment, and the uptake of gold loans was affected.

A lesson to learn

One of the key learnings from the pandemic and its aftermath is that in periods of acute economic distress, the wider financial services sector (banks and non-banks alike) is also put to severe stress. The consequence is that lending activity slows down drastically as the appetite for risk and disbursing new loans falls.

With risk aversion running high, often the only loan available in the market to the masses was gold loans. Earlier, this would have meant approaching a specialised gold loanNBFC or a pawnbroker. These days banks have also upped their gold loan game.

Besides, as a strategy, increasing your lending against a liquid collateral that preserves its value during economic distress is a no-brainer. At the same time, a word of caution is in order. About a decade ago, many banks and NBFCs had forayed into gold loans, lured by the example of gold loan-focussed NBFCs whose business had boomed in the preceding half decade.

The crash in gold prices in 2013 was a rude wake-up call. Most of these new entrants took the exit route as fast as they had come in. The need to set up robust risk management processes before taking the plunge was now clear. An essential component of risk management in gold loans is the auction policy. It matters a lot, especially in a scenario of volatile gold prices. Among the unbanked, gold is not so much an investment as much as an avenue to park one’s savings in. After the harvest, when small farmers end up with surplus money on their hands, they often buy gold as they lack access to banks.

Later, in the sowing season, when they need money the most, they may either sell the gold or pledge it to draw cash.

This is how things have been going on for ages. And sometimes, it can happen that financial adversity leaves the borrower no choice but to let go of his gold, and this is also part of the game. In recent days, gold loans going into auction have become a subject of animated discussion in the media as part of the wider narrative about distress in the economy.

While the suffering is real and undeniably a factor responsible for higher auctions, the impact was also aggravated by the price of gold, which has corrected sharply from the all-time highs of August 2020. In the seven months up to March 2021, gold price fell by over 20 per cent; a fall of this magnitude was last seen in 2013. The unexpected confluence of a raging pandemic and a sudden crash in gold price fed into higher auctions.

An unhappy experience

Since losing one’s gold is an unhappy experience for all, industry players have given much thought to how this may be minimised. One of the changes that has come about is the insistence by lenders on periodic payments of accrued interest.

Traditionally, the gold loan product carried a tenor of one year and bullet repayments of both principal and interest was the norm. But now, with periodic interest payment, the compounding burden on the borrower is lessened. A few have gone further.

For instance, at Manappuram Finance, we opted for a short-term gold loan product as the best way to manage the gold price risk. It offers benefits both to the borrower and to the lender. The lending firm can manage the price risk and asset quality prudently without taking away flexibility from customers in respect of their credit requirements. Customers can renew the loans indefinitely by periodically settling the interest and resetting the principal to the prevailing gold price. This avoids the risk of a compounding interest piling up over the course of the year.

However, we must acknowledge that the gold loan sector cannot hope to be fully immune to the vagaries of the wider economy.

(The writer is the MD & CEO of Manappuram Finance.

Views are personal)

Although yet another non-banking finance company (NBFC) is going the Dewan Housing Finance Corporation (DHFL) way and is being put through a debt-resolution process under the Insolvency and Bankruptcy code (IBC), this is unlikely to snowball into a bigger crisis as the country’s shadow banking sector is fairly resilient and adequately capitalised.

According to senior industry experts, there has been an improvement in the liquidity position of most NBFCs and business has been coming back to normal, both in terms of disbursements and recovery. So, there is no need to press the panic button yet.

Governance concerns

It is to be noted that the Reserve Bank of India (RBI) had, on October 4, superseded the boards of Srei Infrastructure Finance and Srei Equipment Finance, owing to governance concerns and defaults by the companies in meeting various payment obligations. It appointed Rajneesh Sharma, Ex- Chief General Manager, Bank of Baroda, as the administrator for these companies.

This is the second instance of the RBI invoking IBC provisions against an NBFC. The first time the central bank had initiated the process of resolution against an NBFC (DHFL) under the Insolvency and Bankruptcy (Insolvency and Liquidation Proceedings of Financial Service Providers and Application to Adjudicating Authority) Rules, 2019, was in 2019.

A special audit conducted by the RBI in December 2020 and January 2021 revealed ever-greening of loans, negative capital-to-risk (weighted) assets ratio (CRAR) and default in payments of over ₹10,000 crore to lenders, prompting it to supersede the boards of Srei Infrastructure Finance and Srei Equipment Finance. The Kolkata bench of the National Company Law Tribunal (NCLT) admitted the applications filed by the RBI on October 8 for initiating corporate insolvency resolution process against against the two Srei companies – Srei Infrastructure Finance and Srei Equiment Finance.

However, it is unlikely there will be any more new additions to the list of NBFCs to go under resolution, opine experts.

“This (Srei) has been on for quite some time now. It is not new. But we are not hearing of any new names (as of now). As of now, things look okay (for other NBFCs). Funding side has been better than what it was last year. Entities have been able to raise capital. So, capitalisation numbers have been okay.

“Though asset quality numbers for September are yet to come, from what we hear, disbursements are picking up, collections are improving. So, hopefully things should stabilise,” Karthik Srinivasan, Senior Vice-President, Group Head, Financial Sector Ratings, ICRA, told BusinessLine. According to YS Chakravarti, MD & CEO, Shriram City Union Finance, there are ups and downs in every industry, and the same would be true for the financial services sector as it is also not immune to the vagaries of nature and market.

“There are successes and there are failures…..it is not something terrible. Since it is a financial services industry, we should not blow it out of proportion. A majority of the NBFCs are comfortable on the liquidity front, they are raising money,” he said.

The RBI, in its latest annual report, said that in the aftermath of liquidity stress post the IL&FS and DHFL events, the market funding conditions turned difficult for NBFCs. “While NBFCs with better governance standards, robust business models and efficient operating practices did well and could raise funds, others bore the brunt of the market forces.

“Smaller NBFCs and microfinance institutions (MFIs), which were contributing significantly to the last-mile credit delivery, also got impacted as their funding sources got further squeezed,” said the central bank. In response, the RBI took several calibrated steps to channel credit flow into the NBFC sector and enhanced supervision to improve the sector’s long-term resilience.

Liquidity position

The IL&FS incident had turned the financial sector players, including banks and mutual funds, cautious in their approach towards NBFCs. That continued for a few quarters, but things were getting back to normal towards the last quarter of FY20.

However, in the first quarter of FY21 Covid broke out, impacting all industries, including NBFCs, and their recoveries were affected.

“But from July last year NBFCs’ liquidity position started improving, backed by several measures announced by the central bank, including TLTRO and partial credit guarantee scheme.

“By second half of last year, things were coming back to normal, but again in Q1 of the current fiscal, we had the second wave of Covid. So, their disbursements and collection efficiency came down,” Krishnan Sitaraman, Senior Director and Deputy Chief Ratings Officer, CRISIL Ratings, told BusinessLine.

Capitalisation has improved for a number of NBFCs, which helped them lower their leverage levels, and there has been an improvement in their liquidity position. Though there has been a drop in the collection efficiency, it is better than the situation last year. “On the balance sheet side, many of them have enhanced their resilience through provisioning, liquidity, capital. While larger entities may be able to manage the situation (better), smaller ones may face trouble for some more time.

“Funding access to NBFCs, particularly the larger ones supported by strong parent and highly rated, is improving. Some consolidation may happen (moving forward) where a larger NBFC may acquire a smaller one …. but I don’t see any reason for pressing the panic button,” said Sitaraman.

Small depositors, bondholders

The recovery is believed to be better and it also takes a shorter time (for recovery) through the IBC process.

However, it sometimes may lead to a huge haircut for lenders and a tough deal for small depositors and bond holders of NBFCs. According to Sitaraman, it is unlikely that there will be a significant impact of NPAs in the NBFC sector on the balance sheet of banks as they do not have a very big exposure in the sector. The total NPAs in the banking sector is estimated to be close to ₹8-lakh crore.

Even while the overall NPAs are expected to go up to around 8-9 per cent, those on account of NBFCs may not contribute to a significant chunk.

The asset quality of scheduled commercial banks improved during 2021-22 (up to June), with the overall non-performing assets (NPA) ratio declining to 7.5 per cent in June 2021 from 8.0 per cent a year ago, according to the RBI’s latest monetary policy report.

According to the RBI’s latest financial stability report, gross NPAs of NBFCs declined to 6.4 per cent (provisional based on data of 276 NBFCs of total asset size ₹38.8-lakh crore) as of March-end 2021 against 6.8 per cent as of March-end 2020. Their CRAR improved to 25 per cent from 23.7 per cent.

However, it will be a bloodbath for small investors and bond holders in companies such as Srei, said Mamta Binani, an insolvency resolution professional.

“Small investors and bond holders will be put at the mercy of law and it will have a crippling effect,” she said.

Small depositors and bond holders are typically considered unsecured creditors, and they tend to get whatever is left after paying the secured creditors.

The monetary policy committee left rates unchanged and continued its stance of maintaining accommodative stance on Friday. The Governor went to great lengths to “not rock the boat”, as he stated, particularly with the shore (end of the pandemic) in sight and given the need to prepare for journey beyond the pandemic. But the bond markets were not too impressed, with the 10-year G-Sec yield hardening 5 basis points to close at 6.318 per cent on Friday.

Tough balancing act

The central bank has a tough balancing act to begin moving towards policy normalisation like other central banks while ensuring that economy and markets are not disrupted.

Surging liquidity surplus means it cannot continue supporting the bond market. Surplus liquidity averaged ₹9.5-lakh crore in October, up from ₹7-lakh crore in the June to August period.

There were two measures announced to manage the surplus and short-term rates. One, further G-SAP auctions have been halted, though the central bank said it would conduct G-SAP auctions and other liquidity management tools such as operation twist and open market operations, should the need arise.

Two, it plans to increase the quantum of the 14-day VRRR auctions to increase it to ₹6-lakh crore by December and conduct 28-day VRRR, if needed. The Governor has assured that even with this, liquidity absorption under fixed rate reverse repo would still be ₹2-lakh crore to 3-lakh crore by December

The cessation of the G-SAP auctions is a negative for bond markets as it reduces the absorption of G-Secs to that extent.

Banking on other tools

While the central bank promises to use other tools to balance the supply, the G-SAP auctions gave visibility to bond markets, which is now withdrawn.

VRRR auctions will not alter the liquidity in the system as the RBI is only trying to move the existing liquidity to these auctions, where it will have greater control over rates; the intention is to move short-term interest rates higher. This is expected to be a precursor to moving reverse repo rate higher in the upcoming policies.

The bond market is worried because supply will remain elevated though demand is being reduced.

With the need to sterilise capital flows, liquidity is expected to remain elevated. Also, the market is not entirely convinced about the lowered inflation projection.

“In the absence of durable absorption, it is unlikely that the short end rates would directionally move closer to the policy rates. Market direction is expected to remain volatile as the overhang of additional measures would remain.

“Even as the near-term domestic CPI prints may provide some relief, external factors such as commodity prices and unwinding of monetary accommodation globally could counter balance that,” says Rajeev Radhakrishnan, CIO – Fixed Income, SBI Mutual Fund. “Liquidity management is also hamstrung by the RBI unwinding of forward premia by as much as $23 billion in the last couple of months.

“If the RBI wants to discourage liquidity injection in lieu of such unwinding, as the MPR notes, the resultant rollover can trigger a vicious cycle of higher inflows and even further increase in the forward premia,” notes Soumya Kanti Ghosh, Group Chief Economic Advisor, SBI.

Global risk aversion

Further, if global risk aversion increases, there could be higher FPI outflows from G-Secs, applying upward pressure on yields. With all these tailwinds, bond yields can inch higher in the coming week.