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The year 2012, has witnessed huge hue and cry over the gold price and purchases by the public. The sale of coins by Banks has also been seen as against the national interest. All this lead to setting up of "Working Group to Study the Issues Related to Gold and Gold Loans by NBFCs in India. The working group has submitted its draft report for comments in early January, 2013. It is an interesting and exhaustive report. We give below some of the extracts of the this DRAFT report, which can be useful for students preparing for exams and for bankers who are interested the subject and issues relating to Gold :-
Introduction About Gold Demand in India :
Gold has always fascinated the mankind’s imagination and influenced their urge to possess the same. Gold occupies a pivotal role in the social and economic life of poor and rich alike. In India, besides the economic and strong social considerations, individuals are highly sentimental about the gold jewellery in their possession, as the gold ornaments are passed on from one generation to another. Acquisition of gold is considered auspicious and necessary for making family ornaments to get a sense of wellbeing in our country. Gold is increasingly considered as an investment that appreciates over years and provides a hedge against inflation. Gold is also considered as a medium that can be pledged easily during difficult times for securing financial accommodation
India is known to be the largest importer of gold in the world. The imports of gold by India have been rising unabated in recent years notwithstanding the sustained increase in gold prices. Such large import of gold, when the gold prices are ruling high is one major source of bulging trade deficit. The deterioration in current account deficit (CAD) due to large gold imports has implications for financing the same, which would reduce the foreign exchange reserves and could become a drag on the external debt. In this context, a major concern emerged is the impact of huge gold imports on external stability
Changes in the Gold Loan Market in Last Few Years :
Concurrently, the gold loan market in India has shown rapid strides. While gold loans were provided by money lenders and pawn brokers for several centuries and availed extensively by people from all walks of life, the more recent years witnessed a transformation of the gold loan business with a decisive shift in the players from unorganized sector to organized sector like the banks and specialised non-bank financial institutions undertaking it in a big way. The rapid rise in the number of institutions involved, their branch network, volume of business in terms of gold pledged, volume of loans disbursed brought new dimensions to the gold loan market. In the post crisis period, personal loans have become costlier with frequent upward revisions in interest rates by banks and financial institutions. Individuals, petty traders, borrowers in the low and middle income group resorted to taking loans by pledging their gold jewellery with banks and gold loan non bank financial companies (NBFCs) to meet their funding requirements. The traditional and ubiquitous pawn brokers are known to charge usurious rate of interest. Therefore, there has been a rapid increase in the number of individuals and business entities seeking gold loans approaching the banks and the gold loan NBFCs in the organised sector to meet their consumption as well as funding needs. As the demand for gold loans increased at a scorching pace in recent years, the gold loans NBFCs have started expanding their operations at a hurried pace through opening of their branches rapidly across the length and breadth of the country. To accommodate the large demand for such loans, these NBFCs have also increased their reliance on bank and other borrowings on a massive scalecontent content content
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Viewed against these developments, it was apprehended that there could be systemic concerns arising out of huge borrowing of public funds by these companies. Further, the business model adopted by certain large gold loan companies especially relating to lending against gold could expose them to ‘concentration risk’ as more than 90 per cent of their assets are concentrated only in gold jewellery loans. Simultaneously, there has been a spurt in the number of complaints received against these NBFCs, about some anti-borrower business practices followed by them. The large scale branch expansion would require strengthening of the safety procedures, corporate governance and internal control processes in the NBFCs. Some of these NBFCs are also accepting retail public funds styling them as ‘non convertible debentures’ and such instruments are issued for periods less than 90 days besides being made available to investors on tap. The lack of absolute transparency in procedures adopted by these NBFCs for auctioning the pledged gold has been a matter of concern. There are also complaints against NBFCs that in order to quickly dispose the cases relating to gold loans, proper documentation process are not being followed. Such deviations will have implications for the KYC norms. The auction procedures followed by these NBFCs have also led to many complaints against them
Factors affecting the demand for gold
It is well known that the demand for gold in India is influenced by many social, economic and cultural factors. The price of gold, rural income distribution, quantum of black money, rate of return on alternate financial assets and the general price level are major driving factors for gold demand in India. The performance of gold against other comparable domestic assets over the last few years is suggestive of the shift towards gold in India also. Returns from gold investment have outperformed other comparable assets on three of the last five years.
Trends in gold prices
International gold prices have risen exponentially in the last decade. Since 2000, the international gold prices have grown at compound annual growth rate of 16.3 per cent. The domestic gold prices have moved in tandem with international gold prices in recent years. Volatility in international gold prices in recent quarters is positively skewed implying that it provides fewer large losses and a greater number of larger gains. One of the major components of gold demand in recent years has been investment demand at the global level. Rising gold prices in recent years did not deter the acquisition of gold in India, implying that investment in gold is becoming price inelastic.
Large gold imports led to concerns in the macroeconomic management
The management of demand and supply of gold has important policy implications for fiscal policy and exchange rate management. With domestic production of gold falling to insignificant level, the gold consumption is met entirely through imports. Though it is generally considered that a CAD of 2.5 to 3.0 per cent is sustainable for India, in the more recent years CAD is very high. In 2011-12, external sector resilience has weakened mainly due to higher current account deficit, which in turn was largely on account of worsening trade deficit. Two commodities that led to higher imports were oil and gold. Gold contributed nearly 30 per cent of trade deficit during 2009-10 to 2011-12, which is significantly higher than 20 per cent during 2006-07 to 2008-09. The large gold imports, thus, have led to major concerns in the macroeconomic management.
Gold imports appears to be making India’s external sector vulnerable
During 2011-12, high trade deficit caused, inter alia, by high gold imports led to worsening of the CAD. Had the gold imports in India grown by 24 per cent (an average of growth in world gold demand during part three years) instead of 39 per cent in 2011-12, the current account deficit would have been lower by approximately US$ 6 billion and CAD-GDP ratio would have been 3.9 per cent instead of 4.2 per cent. Thus, gold imports are putting pressure on the Balance of Payments management. The current trend in quantum of gold imports appears to be making India’s external sector vulnerable in terms of rising trade and current account deficits, which in the absence of adequate foreign capital flows, can have implications for maintaining adequate foreign exchange reserves buffe
Micro and Institutional Issues
Developments in gold loan market
While the gold imports surged, concurrently, the gold loan market in India has shown rapid strides. The swift rise in the number of institutions involved, their branch network, volume of business in terms of gold pledged, volume of loans disbursed brought new dimensions to the gold loan market. To accommodate the large demand for such loans, these NBFCs have also increased their reliance on bank and other borrowings on a massive scale. It was apprehended that there could be systemic concerns arising out of huge borrowing of public funds by these companies. Simultaneously, there has been a spurt in the number of complaints received against these NBFCs.
Reasons for sharp expansion in gold loans
There are several reasons for the sharp expansion in gold loans in recent years. NBFCs positioned gold loans as a convenient tool for raising loans. Geographical expansion of gold loan companies facilitated the loan delivery. Flexibility of loan options, liberal Loan to Value Ratio, easy to conform documentation led to expansion of gold loans. The average size of the gold loan increased due to the rapid price increase of the gold and constricted availability of retail and personal loans from banks.
Concerns related to rise in the activity of gold loans
Numerous apprehensions arose due to the rapid rise in the activity of gold loans NBFCs. They are systemic concerns arising out of huge borrowing of public funds by these companies; possibility of ‘concentration risk’ as more than 90 per cent of the assets are concentrated only in gold jewellery loans; and whether large scale branch expansion ensured strengthening of the safety procedures, corporate governance, internal control processes in the gold loans NBFCs. Some of these NBFCs are soliciting retail public funds styling them as ‘debentures’ and such instruments are issued for periods less than 90 days besides being made available to investors on tap. Further, the lack of transparency in procedures adopted by these NBFCs for auctioning the pledged gold has become a concern. There are also complaints against NBFCs that proper documentation process was not being followed with implications for the KYC norms. The auction procedures followed by these NBFCs have also led to complaints against them. Spurt in the number of complaints received against these NBFCs about overcharging of interest. These developments have necessitated a comprehensive study of the functioning of the gold loan NBFCs.
Against these macroeconomic concerns and institutional developments, it was considered appropriate by the Reserve Bank to constitute a Working Group to examine the issues related to gold imports and gold loans provided by the NBFCs.
III. Views of the Working Group:
With large gold imports, external stability appears to be an issue
The Working Group is of the view that external stability appears to be an issue with large gold imports. Gold contributed nearly 30 per cent of trade deficit during 2009-10 to 2011-12. Due to falling gold re-exports, India’s trade deficit as well as CAD as ratio to GDP worsened by 0.3 percentage points in 2011-12. Projections show that net gold imports as ratio to GDP is likely to be in range of 1.8 per cent to 2.4 per cent in the next few years.
Demand for gold may not be fully amenable to policy changes
Demand for gold appears to be autonomous and a function of several influences and factors in India and may not be strictly amenable to policy changes. Supply of gold, through organised channels can be constricted, but buyers may take recourse to unauthorised channels to buy gold. The share of banks in importing gold has already been on decline over the years. Since it is difficult to vary the demand for gold the policy focus will have to be directed to (i) design and offer gold investors, alternative instruments that may fetch positive returns with a flexibility of liquidity; and (ii) increased unlocking of the hidden value locked in idle gold stocks through increased monetisation of gold. In this context encouraging gold jewellery loans from Banks and NBFCs, ensuring customer protection of borrowers and changes in the practices of NBFCs is desirable.
(i) Resolution of macro issues
Given this scenario, there is a need to moderate the demand for gold imports. We need to opt for a series of demand reduction measures, supply management measures and measures to increase the monetisation of gold.
a. Demand reduction measures
b. Supply management measures
c. Measures to increase the monetisation of gold
(ii) Addressing the micro and institutional issues
Liability management - Need for careful monitoring of the gold loans NBFCs’ operations
The rapid growth of the assets, borrowings and branch network of gold loans NBFCs need to be monitored continuously through more frequent review of relevant data for large gold loan NBFCs. There is a need to reduce the interconnectedness with the formal financial system over medium and long run. Keeping in view the declining capital adequacy ratio, there is a need to improve the capital. There is also a need to review the current stipulations pertaining to raising resources through NCDs. The exemption available to secured debentures from the definition of “deposit” may be reviewed. It is necessary to monitor the transactions between gold loans NBFCs and their respective sister concerns and unincorporated bodies.
Customer protection - Need for reviewing of the gold loans NBFCs practices
The practices followed by gold loans NBFCs needs a relook to ensure customer protection. In this regard, there is a need to ensure transparent communication of loan terms. Institution of a customer complaints and grievances redressal system is important. Auction procedures need a relook. Auctions should be conducted at a price closer to the market price. Disclosure standards need review. Monitoring the implementation of the Fair Practices Code is urgent. Standard documentation procedures may be devised. Use of PAN Card for large transactions is desirable. Large transactions of gold loan NBFCs may be through cheque to ensure KYC stipulations. There is a need for an ombudsman to address the grievances of gold loan borrowers.
Prudential norms - Review the regulatory framework pertaining to gold loan NBFCs
Coming to the regulatory norms relating to gold loan NBFCs, the Working Group’s assessment is that, as of now, there is no case for conceding complete level playing field for the gold loans NBFCs with the banks. There is a need to review the extant ‘loan to value ratio’. There is also a need for a well-defined and standardised concept of the term ‘Value’ for prescribing appropriate ‘Loan to Value Ratio’. Unbridled growth of branches by large gold loans NBFCs needs to be moderated. Rationalisation of interest rate structure of the gold loans NBFCs is a priority. Though leverage of the gold loans NBFCs is not a cause for worry at the present juncture, going forward, there is a need for improving owned funds of the NBFCs.
Gold loans NBFCs do not pose a problem for domestic financial stability currently
As of now, gold loans NBFCs do not pose a problem for domestic financial stability. Going by the past trends, a sudden drop in gold price by 30 to 40 per cent is a remote possibility causing any financial distress to the gold loans NBFCs. Asset quality, NPAs as per cent of total credit exposure and Capital adequacy of gold loans NBFCs are also not a cause for concern at present. The sources of funds of gold loans NBFCs also do not appear to be an immediate cause for anxiety giving rise to ‘concentration’ credit risk. However, the striking growth of gold loans NBFCs business in recent years warrants that their operations may be closely monitored.
Some empirical findings
The technical work undertaken by the Working Group indicated that gold loans have a causal impact on gold imports substantiating the emergence of a liquidity motive for holding gold. But, it should be clearly recognised that availability of gold loans alone cannot push up gold imports. International gold prices and exchange rate significantly and positively affect the gold prices in India. Probability of volatility in gold prices impacting the gold loan market is low. Increase in gold prices appears to be one factor that increases the gold loans outstanding. However, increase in gold loans extended by NBFCs and banks do not impact significantly the gold prices in India. On the basis of empirical analysis of volatility in gold price, it is difficult to estimate future prices of gold. Going by the past trends, a drop in gold price by 30 to 40 per cent is a remote possibility causing financial distress to the gold loans NBFCs. Banking sector’s existing exposure in the form of their individual gold loans appears small and may not have any significant repercussions for the stability of the banking sector at present.
IV. Summing-up:There is a need to moderate the demand for gold imports, as ensuring external sector’s stability is critical. But, it is necessary to recognise that demand for gold is not strictly amenable to policy changes and also is price inelastic due to varied reasons. What is critical is to ensure provision of real returns to investors through various financial savings products. What is also relevant is the need for banks to introduce new gold-backed financial products that may reduce or postpone the demand for gold imports. The Working Group believes that providing real rate of return to investors through alternative instruments holds the key to reducing the excessive demand for gold. Meanwhile, there is also a need to increase monetisation of idle gold stocks in the economy for productive purposes. As of now, there appears to be no close substitute to wean away investors’ attention from gold. Investors’ awareness and education is important, in this context, to channel the investment to gold-backed financial products. Banks and NBFCs may continue to deliver gold jewellery loans, which monetises the idle gold in the country. The gold loan market has grown well in recent years. It is time for consolidation of the operations of the gold loan NBFCs. The gold loans NBFCs need to transform themselves into institutions free of complaints, have proper documentation and auction procedures, with rationalised interest rate structure and have a branch network that is fully safe and secure. Gold loans NBFCs’ linkage with formal financial institutions may be reduced gradually. Such transformation ensures the gold loans NBFCs’ future growth more robust, besides making them a contributing segment to the financial inclusion process
Source : RBI Website.