News Analysis

RBI Policy: Increase in LTV on gold, poses risk to both for lenders and borrowers

Rajalakshmi Nirmal BL Research Bureau | Updated on August 06, 2020 Published on August 06, 2020

While NBFCs were allowed to lend over 75 per cent of the value of gold, the RBI had restricted banks from lending over 75 per cent of the value of gold. On Thursday, this cap for banks on LTV for gold loans was raised to 90 per cent till March 31, 2021.

While the move can give immediate liquidity to borrowers, it raises fears of higher risk for banks on their gold loan portfolio.

The yellow metal has had a spectacular rally in the current year and is at its life time high.

However, gold may lose its sheen for the following reasons.

One, if the Federal Reserve doesn’t come up with its next stimulus package soon. Two, if the stimulus package negotiations fail. Three, if for some reason the US dollar climbs higher.

The rupee’s appreciation may also see gold prices drop for domestic consumers.

When the correction happens in gold price, one can’t be sure about its extent, given year-to-date returns in the metal is 33 per cent in USD terms and 42 per cent in rupee terms.

In case of an over 5-10 per cent drop in gold price in the next one month, banks that lent money at 90 per cent LTV will be in a spot of bother.

Looking from the standpoint of a gold loan customer too, borrowing at 90 per cent LTV is a risk. If gold prices correct sharply and the bank had lent 90 per cent of value of gold, Naveen Kukreja- CEO and Co-Founder, Paisabazaar.com, says, “The gold loan borrower will be asked to deposit the difference amount in cash/cheque or pledge more gold as collateral with the lender. Failure to do so may lead the lender to sell the gold already pledged as collateral.”

So, think twice before you happily borrow 90 per cent of value of gold.

However, it is noteworthy that even NBFCs currently do not lend up to 75 per cent of gold value. A market check shows that Muthoot Finance is currently lending at ₹3,455/gram – this comes to 64 per cent of the current rate of 22 K gold – ₹5,387/gram.

Data sourced from paisabazaar.com shows that with SBI, Punjab National Bank and other PSU banks, LTV starts from 65 per cent. Thus, it doesn’t look like banks will jump-on to lend at 90 per cent LTV just because RBI has given the nod now without weighing the risks from price volatility in gold. But if they do so, there are risks.

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Published on August 06, 2020
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