Indian gold loans on the rise again

Loans backed by physical gold appear to be increasing again in India, as shown by quarterly data and statements from the management of Muthoot Finance, one of the biggest lenders in the country’s non-bank sector. This past spring India's central bank tightened regulations affecting firms in the growing non-bank financial sector. These measures were partly aimed at minimising the risks associated with gold-backed loans.

According to Oomen Mammen, Chief Financial Officer at Muthoot Finance, in the past two months demand for so-called gold credits has risen significantly. In spring the Reserve Bank of India (RBI) requested that commercial banks reduce from 10% to 7.5% credit granted to financial firms in the non-banking sector. These measures were mainly aimed at avoiding a flood of margin calls triggered by possible further price drops in gold and other precious metals.

The gold price dropped as low as $1,525 per troy ounce during its recent correction phase, although the yellow metal has since recovered and is now back above $1,700/oz. Nevertheless, the RBI has continued with its new stricter gold-credit regime. This has meant that firms in the country's gigantic non-bank financial sector have been barred from accepting gold coins or gold bars as collateral for loans. Since this spring such credits can only be backed by gold jewels. The RBI also stipulated that such loans can no longer exceed valuation of gold based on more than 60% of the current spot price.

The RBI's measures were met with little criticism, as those beneficiaries who were backing loans with gold purchased at or close to last summer’s record highs already had negative asset balance, i.e. the actual price of the gold used as back-up could in many cases not cover the value of loans. Had this gap widened further, the affected debtors would have been forced to make subsequent payments to cover the shortfall. Defaults mean creditors often end up losing money in these circumstances.

In Q1 Muthoot Finance suffered a loss of more than 5%, although the firm's profits have been rising since then.