How gold holdings can ease credit flows

If gold held by the top 30% of Indian households can be mobilised, it can be used for dollar swaps, while depositors could be provided low-cost credit for longer tenures

In 2019-20, Indian non-bank finance companies (NBFCs) engaged in extending loans against gold as collateral were a hit with international investors. Muthoot Finance raised $550 million via dollar bonds at a coupon rate of 4.4 per cent, following the $450 million it raised in 2019. Interestingly, the bond issue was actually launched at 4.75 per cent, but owing to international investors’ interest, the company got a lower yield. Mannapuram Finance at the same time raised $300 million at 5.9 per cent, compared with the initial offer of 6.25 per cent, while Rupeek, an online lending platform, has raised nearly $60 million since its inception in 2015. News reports say Indian NBFCs together aim to raise about $2.5 billion from overseas bond issuances. 

What is common to these companies? It is their portfolio of retail loans which is largely backed by gold as collateral. According to CARE Ratings, the three-year compound annual growth rate (CAGR) of the top seven gold loan NBFCs (with assets under management of over Rs 1,000 crore) was 11.5 per cent, as of 2018-19. Their total advances were Rs 70,500 crore, or 15.8 per cent of the approximately Rs 4.55 trillion of retail credit issued by NBFCs. This would imply enormous potential to develop a secured credit portfolio by NBFCs, where gold is the collateral. 

Where do a circular economy and gold come into this scenario? A circular economy is an economic system where resources are reutilised without creating the need to produce them again. Globally, it is projected to create a $4.5-trillion opportunity by 2030, according to a report presented at the annual meeting of the World Economic Forum. Gold holds much greater significance, if one looks beyond the conventional definition of a circular economy. 

In India, there are monetisation possibilities, and global investors are now eyeing this market. Betweeen Muthoot Finance, Muthoot Fincorp and Mannapuram, there is an estimated 200 tons of gold held as collateral on an annual outstanding basis. Gold held as collateral by organised lenders overall may amount to an estimated 1,280 tonnes. A large proportion of this circulates and is not getting monetised.

Scheduled commercial banks, co-operative banks, small finance banks and Nidhi companies also provide loans against gold. A large private sector bank has loaned Rs 5,900 crore against gold, while a nationalised bank extended about Rs 45,000 crore in gold loans in 2018-19. Until recently, scheduled commercial banks provided loans against gold under priority sector lending, as part of a larger strategy to increase the share of risk-mitigated credit. Some banks even provide overdrafts on gold holdings.

It would be fair to say that loans totalling at least Rs 3 trillion are being extended through organised lending, including both retail credit and agri credit, where gold is offered directly or indirectly as collateral. And this is short-term credit with the lowest default rate. Assuming an average loan-to-value ratio of 70 per cent, the total value of gold stored as collateral will be about Rs 4 trillion. These loans are used for value-added activities such as installing a pump set for farming, or starting a new business. And the institutions are more willing to provide credit against collateral that is liquid. Naturally, it makes business sense to give investors access to low-cost funds in the international market with a three-year maturity, and make them part of this growth story.

Here we are here discussing only the organised market. Non-institutional sources of secured credit are just as big. They are all popular because of intra-community lending. According to the All India Investment and Debt Survey 2012, only the following states had more than 10 per cent of debt in gold loans: Manipur (14.2 per cent), Kerala (17.2 per cent), Tamil Nadu (41.3 per cent), Andaman & Nicobar Islands (13.1 per cent), and Puducherry (50 per cent). Despite the high gold holdings, non-institutional and unsecured debt is very high. The Reserve Bank of India Household Finance report has clearly shown the gains in income following a shift from non-institutional to institutional credit. And if these are backed by gold, the gains could be higher.

Looking at the size of the market and the current need to inject liquidity into the hands of the public owing to the crisis caused by Covid-19, gold held by Indian households provides a way to maintain credit flow and liquidity in consumption markets.

The US Federal Reserve has announced unlimited quantitative easing, as a result of which financial institutions will be flush with cash. They will be looking to deploy it in a high-yield market, and the timing could not be better for Indian institutions to directly tap the overseas market at a lower cost. As an added bonus, if gold in the hands of the top 30 per cent of households can be mobilised, it can be used for dollar swaps, while depositors could be provided low-cost credit for longer tenures. This is a privilege that only the Indian economy can consider. The writers are with the India Gold Policy Centre at IIM-Ahmedabad