Correction in gold price likely to make 90% LTV risky for borrowers

Those in dire financial straits may find it difficult to pay the margin demanded by lenders

Keeping the impact of the Covid-19 pandemic on households in mind, the Reserve Bank of India (RBI) on Thursday allowed borrowers to take a higher amount as loan against gold, by increasing the permissible loan-to-value (LTV) ratio on gold loans for non-agricultural purposes from 75 per cent to 90 per cent.

If you have gold worth Rs 1 lakh, you can now get Rs 90,000 as loan, instead of the earlier limit of Rs 75,000. This relaxation will be in effect till March 31, 2021. Says Padmaja Chunduru, managing director and chief executive officer (CEO), Indian Bank: “This will help small businesses, micro and small units that have availed of a gold loan for business needs.”

While this is a reasonable move keeping the current situation in mind, it could also turn out to be a double-edged sword for borrowers and lenders. Gold prices have hit record highs over the past few months. On August 7, gold futures touched Rs 56,065 per 10 grams on the MCX. Experts believe gold prices will eventually take a downward turn. In that case, the indiscriminate use of such loans could create problems. Says Mrin Agarwal, founder of Finsafe India: “In case of a correction in the price of gold, the LTV ratio of a gold loan could exceed 90 per cent. Then the borrower will have to deposit the exceeded amount.” She might have to pay the amount through cash or cheque, or pledge more gold as collateral with the lender. If the borrower fails to do so, the lender might sell or auction the gold already pledged.

For existing gold loan borrowers, where the LTV is 75 per cent, the increased LTV limit could prove to be a blessing. Says Naveen Kukreja, CEO and co-founder of Paisabazaar.com: “The increased LTV of 90 per cent may provide relief to existing gold loan borrowers in case of a steep correction in gold prices in the near term.”

 

While the RBI has increased the regulatory cap on gold loan LTV ratio offered by banks, the latter will be free to set their own gold loan LTV ratio limits, depending on their risk appetite, the trajectory of gold prices, and the credit risk assessment of each borrower.

Being a secure loan, this is relatively easy to get. Any Indian adult below the age of 75 can avail of a gold loan. But all gold loan applicants might not get a 90 per cent LTV ratio. Even if you have a job or a fairly good credit score, you might not get the 90 per cent LTV because this move has an impact from the lender’s point of view, too. Says Chunduru: “LTV of 90 per cent in an increasing gold price scenario is fine. We must, however, keep an eye on the margin because 10 per cent is a small cushion.”

 

Going for the higher LTV might not be advisable for borrowers who do not have additional resources. Says Agarwal: “Due to the extra 15 percent­age point increase in LTV, your inter­est cost will certainly increase. It’s not a good idea to exhaust the 90 per cent limit on LTV. It will be better to be at a lower level.” One should try to manage within the 75 per cent LTV to avoid a margin call when the price drops.