Gold loan players should guard against possible fall in prices, says Fitch Ratings

The surge in gold prices since the start of the coronavirus pandemic increases the asset quality and collateral risks that gold loan companies will face if the price falls, cautioned Fitch Ratings.

The higher price of gold has helped to buoy loan growth by some Indian non-bank financial institutions (NBFIs) or gold loan companies that lend against the metal, the credit rating agency said in a report.

“This will bolster interest income, but the trend also raises potential risks associated with a fall in gold prices,” it added.

The agency opined that a regulatory loan-to-value (LTV) cap on gold loans by NBFIs of 75 per cent provides a buffer against these risks.

Fitch assessed that some lenders have reduced internal LTV caps below the regulatory ceiling to better manage collateral risks in the near term.

Average LTV ratios on outstanding gold loan portfolios for Fitch-rated entities are in the 55 per cent-65 per cent range, having fallen as a result of the recent increase in the value of gold collateral.

The report observed that growth in India’s gold-backed lending may outperform other parts of the financial sector in the near term, as the product’s secured nature and higher gold collateral valuations appeal to both borrowers and risk-averse lenders alike amid pandemic-driven economic uncertainty.

Higher LTV for banks

Fitch said one factor that will add to risks during this latest upturn in the gold price is the Reserve Bank of India’s recent decision to allow banks to lend against gold at LTV ratios of up to 90 per cent until March 2021.

If banks opt to exploit this higher LTV rate, they could pose a competitive threat to gold-focused NBFIs, and might pressure smaller entities in particular to lend at higher LTVs, increasing risks associated with their new lending. However, Fitch believes that gold lenders with strong franchise networks will be better-insulated against such competition.

Impact of fall in gold prices

Fitch said gold prices could fall if the global economic growth outlook improves, leading to reduced risk aversion by international investors. If this in turn strengthened the outlook for India’s economy, it could support Indian borrowers’ ability to repay debt, mitigating lenders’ exposure to falling collateral values.

However, in practice, the global economic cycle will probably have a limited effect on local borrowers’ incomes, which tend to be more rural-centric and dependent on local-area activity, it added.

Moreover, Fitch believes a lower gold price may trigger intentional defaults by some borrowers – particularly if outstanding loan amounts start to exceed the market value of collateral pledged, as they did during periods of significant decline in 2012 and 2013.

Fitch rated borrowers

“Among Fitch-rated issuers, Manappuram Finance (BB-) and IIFL Finance (B+), both on Rating Watch Negative (RWN), saw loan growth of 4 per cent-5 per cent in March-June 2020, although Muthoot Finance (BB/RWN) reported a decline of 1 per cent in gold loans, which we believe is reflective of the issuer’s lower risk appetite in an uncertain operating environment,” the report said. This compares with loan contraction of 1 per cent for the banking sector as a whole over the period.

The agency said Muthoot Finance, Manappuram Finance and IIFL are all on RWN, which indicates that their ratings could be susceptible to a sudden deterioration in their risk profiles.

Risks in the near term will be centred around asset quality, funding and liquidity, though Fitch continues to view pure gold lending as less vulnerable than many other segments in the current challenging environment.

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