The removal of the priority sector lending benefit to commercial banks, under the agriculture classification, for loans given to (and assignment portfolios from) gold loan companies will marginally diminish the attractiveness for banks to lend to these companies, according to credit rating agency Crisil.

This move will lead to an increase in the gold loan players' borrowing costs by 150 to 200 basis points (100 basis points equal one percentage point), and reduce growth rates in their portfolios to less than 50 per cent annually, over the medium term, said Crisil in a statement.

The Reserve Bank of India had recently announced the removal of the priority sector lending (PSL) benefit available to commercial banks, under the agriculture classification, for loans to (and assignment portfolios from) gold loan companies.

Till recently, most of the bank loans and assignment transactions of gold loan companies qualified for the PSL benefit. Therefore, these entities tended to rely heavily on bank funding — loans from, and portfolio assignments to, banks constituted nearly 75 per cent of these entities' aggregate borrowings as on September 30, 2010.

The PSL benefit has also helped gold loan companies maintain a low cost of borrowings from banks, at 8.0-10.5 per cent.

“We believe that the removal of the PSL benefit, together with hardening interest rates, will lead to an increase in the cost of bank funding for gold loan players. These entities will try to access funds from capital markets more frequently to mitigate the impact of this increase,” said Ms Rupali Shanker, Head – Crisil Ratings.

Crisil believes that this development is unlikely to impact the credit risk profiles of its rated gold loan companies – Manappuram General Finance and Leasing, Muthoot Finance and Muthoot Fincorp.

Despite the expected increase in cost of borrowing, gold loan companies' profitability will remain strong, driven by high yields, improvement in operating efficiencies, and low credit costs, said Ms Shanker.

The net profitability margin of gold loan companies, according to Crisil, is expected to remain comfortable between 4 and 5 per cent, despite declining from the 5-7 per cent levels reported in 2009-10 (refers to financial year, April 1 to March 31).

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