Gold loans have emerged as one of the fastest-growing instruments for both banks and non-banking financial companies (NBFCs). The banks have increased their exposure to this lending category, with strategic partnership with non-bank gold lenders, as a means to de-risk their unsecured lending.

The central bank’s worries on good loans have included prudential aspects such as loan-to-value (LTV) ratios, as high LTVs can expose lenders to substantial risks in case of default. Additionally, the RBI is cautious about borrowers from weaker sections getting in a cycle of indebtedness due to the ease of access to gold loans.

Lenders can sell the gold if borrowers fail repay loans. But this prompts a question: Why is such a move necessary when gold loans often have a comfortable LTV cover and the value of the collateral, gold, tends to appreciate?

Selling NPAs to ARCs allows lenders to expedite the resolution of non-performing gold loans, freeing up capital that can be deployed elsewhere.

However,in cases where the LTV is adequately covered, and if gold prices have surged, the need for such transfers may seem counter-intuitive. This underscores the importance of reviewing and fine-tuning the regulatory framework for gold loans, possibly incorporating tokenisation to streamline the lending process, enhance transparency, and reduce the incidence of default, benefiting both borrowers and lenders.

Leveraging blockchain

Tokenisation, leveraging blockchain technology, can democratise access to gold loans digitally, offering an alternative path to financial recovery for those in need.

In a gold loan tokenisation system, a trusted custodian or financial institution would safeguard the physical gold acting as collateral for the digital tokens.

This process involves verifying the authenticity and quantity of the gold, after which digital tokens, representing its value, are issued on a blockchain.

These tokens provide the basis for lending, with borrowers presenting them to secure loans, while the custodian ensures the secure storage of the physical gold throughout the loan term.

Upon loan repayment, the tokens are returned to the borrower, and the custodian releases the corresponding physical gold. This arrangement ensures the safety and transparency of the collateral and facilitates efficient lending processes.

In the tokenisation process, addressing the common man’s understanding of tangible assets is vital. To align with their comfort level, borrowers who’ve repaid only a portion of their loan can receive a corresponding portion of their physical gold back, just as they would expect. This offers flexibility and enhances the security and efficiency of gold lending.

Enhancing transparency

Tokenisation of gold loans enhances governance and transparency within the lending industry. By leveraging blockchain technology, the RBI can establish a tamper-proof and auditable ledger of tokenised assets, ensuring that all transactions are recorded securely and transparently.

Secondly, tokenisation enables more accurate mark-to-market valuations of the gold collateral.

Since the value of tokenised assets is linked directly to the market price of gold, it allows for real-time, precise valuation, reducing the potential for discrepancies and enabling lenders and borrowers to have a clear understanding of the collateral’s worth at any given time.

Moreover, tokenisation can significantly bolster consumer protection. It empowers borrowers by providing them with a digital representation of their collateral and transparent access to the terms and conditions of their loans.

This clarity minimises the potential for disputes and unethical lending practices, ultimately safeguarding the interests of borrowers.

The writer is Policy Researcher & Corporate advisor

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