Striking gold in the business of loans

Usurious moneylenders, cumbersome loan approval processes at banks and lack of access to credit have made gold loan companies shine

A road stretches from the north-east corner of BBD Bag, the central business district of Kolkata, to the famous neighbourhood of Bowbazar where hundreds of jewellery and furniture shops sit cheek-by-jowl, engaged in frenetic business transactions.

Operating from these bylanes are hordes of pawnbrokers and moneylenders who give out loans against gold through informal contracts that have rates that often soar to north of 50 per cent annually.

Also working out of one such street is Subhesh Saha, a man in his early 30's who has become an antidote to usurious moneylending. In essence, Saha is an arbitrager, the kind that would put a twinkle in the eye of any currency trader at Goldman Sachs. Most jewellers lend against gold at interest rates as high as four per cent a month. Saha uses his client's gold as collateral and secures a loan at one or two per cent from a gold loan company, instantly halving the interest burden his client would have paid at the jewellery shop. This shop that was the originator of this transaction gets its principal back while Saha earns a commission of a cool two per cent on the principal.

This is the kind of alternative financing that is beginning to attract not just urban and rural poor but also the upwardly mobile. Many are exploring newer terrains and getting institutionalised, giving banks tough competition. Gold loan companies are at the forefront of this revolution, offering services to people like Saha, or dealing directly with more affluent clients who want money in a flash but don't want to go through the laborious process of applying for a loan at a commercial bank.

George Alexander Muthoot, managing director, Muthoot Finance, the biggest gold loan company in India, prefers tracking his lineage to moneylenders rather than pawnbrokers. He is the youngest of the four Muthoot brothers, who together run 16 businesses—from rubber plantations to hotels. Gold loan still constitutes the biggest share of their businesses.

From 200 branches in the southern states ten years ago, Muthoot now has a network of 3,700 branches across India, with Rs 24,000 crore in outstanding loans — close to the size of entire microfinance industry before the crisis and more than three times what it was around three years ago. In those three years, the company started aggressively acquiring customers in rural areas who use to take loans from moneylenders, along with a high-profile branding exercise. The result is more than 130 tonnes of gold in its vaults, probably enough to warrant an enthusiastic nod of approval from the overseers of Fort Knox. "A gold loan is no longer a loan for a desperate situation. We have made it a smart or a lifestyle loan," says Muthoot.

It’s no surprise then that informal estimates suggest the size of the gold loan business in India is close to Rs 1 lakh crore, with half of it constituted by the unorganised sector , and 20,000 tonne of gold reserves in the form of household jewellery. "The 20,000 tonne gold reserve should equal to 70-75 per cent of India's GDP-the reason behind the growing gold loan business," says V P Nandakumar, executive chairman, Manappuram Group, which recently posted Rs 161 crore in net profits for the quarter ended December 31, 2011—an increase of 117 per cent over the previous one. Nandakumar—who left a high profile bank job to take over the family business-attributes the growth to the aggressive branch expansion as well as the art of lending in just 15 minutes, a forte of gold loan companies.

This is probably the best time for these companies to be in business. Banks have become less liquid or less inclusive while the number of people looking for loans has grown significantly. With average interest rate between 19-22 per cent, and a net interest margin of 9.5 per cent, gold loan companies are basking in the environment of a lenient interest rate regime. Again, success here hinges on quick loan disbursals thanks to no credit appraisals, and giving loans solely on the basis of know your customer norms.

All of this seems to add up to a win-win situation, but not for the Reserve Bank of India (RBI) which wants to take the sheen of gold companies because it deems this kind of business inherently risky and has therefore imposed a number of restriction on free flow of credit to the sector. In a recent directive, the RBI said that non-banking finance companies engaged in giving loans against gold would not be allowed to lend more than 60 per cent loan-to-value (LTV). Earlier, the apex bank had removed the priority sector lending tag for bank loans to non-bank finance companies given against the collateral of gold. In a yet another directive, the RBI recently cautioned investors against two West Bengal-based companies, who were accepting public deposits.

Still, the fact remains that at the lowest strata of society in India, moneylenders rule the world of non-banking finance. Till 2003, 76 per cent of rural households took loans from moneylenders, according to a report of the National Sample Survey Organisation (NSSO). Until the more mainstream banks and credit institutions figure out a way to service the poor or even explore creative ways to offer credit to their wealthier clients, phenomena like gold loan companies will continue to emerge and flourish.