- Date : 26/05/2021
- Read: 4 mins
Gold loans may be cheaper than most types of consumer loans, but falling gold prices have adversely affected demand.
If 2020 was a year of phenomenal demand for gold loans, 2021 is turning out to be quite the opposite. According to the latest RBI data, banks and private lenders registered 132% growth in gold loan volumes last year. However, the gold loan growth curve is showing signs of tapering off, with gold price on a downward slide since January this year.
Slowly but surely, gold loans are becoming more expensive for borrowers. The reason: a drop in the value of collateral and lenders cutting gold loan tenures to guard against a further drop in prices. This is in sharp contrast to early 2020, when demand for gold loans reached a peak, fuelled by job losses and pay cuts. Investors flocked to gold with the stock markets in free fall.
Now, with signs of economic recovery on the horizon, the trend is reversing and investors are selling gold to buy other assets such as equity and government bonds. What does this mean for borrowers and gold buyers? Let’s find out.
Impact on borrowers
Borrowing against gold is often the last resort for Indian families in times of financial uncertainty. Gold loans help one monetise the value of ornaments to tide over short-term hardships. Research shows that default rates on gold loans are a fraction of that for personal loans and other types of debt. According to a study by KPMG, the typical default rate in India is around 1%-2%. This is because most borrowers aim to repay their loans and get their precious family gold back.
However, the average price of gold fell from Rs 51,350 to Rs 46,372 per 10g between January and April 2021. This has had a negative effect on the loan-to-value (LTV) or the maximum amount of loan that can be availed of as per the market value of a given unit of gold. For example, if the market value of 300g of gold is Rs 13,91,160 (46,372 x 300), you can expect to be offered a loan of Rs 12,52,044.
Though the RBI hiked the LTV from 75% to 90%, many lenders are approving loans far below this level. The reason? A sharp fall in gold prices could impact the minimum margin requirement. If that happens, you may be asked to make a partial prepayment to cover the margin amount of 10%. Any reduction in LTV also means a corresponding decrease in the loan amount you can avail of.
Of course, the LTV also depends on the quality and weight of the gold to be pledged. Unfortunately, the drop in prices has meant that you would need to pledge more gold to qualify for a given loan amount. Also, if you have a relatively large loan requirement, the interest rate is also proportionately high. This is because you represent a higher risk for the lender when the price of gold falls. This is also the reason why loan tenures have seen a sharp cut from 270 days to just 90 days.
Experts, however, say that the drop in prices is only a short-term phenomenon as the economic recovery gathers steam. In the short to medium term, gold prices are expected to stabilise, restoring consumer confidence in gold loans.
Impact on gold buyers
Falling prices have brought cheer to consumers waiting for the right time to buy gold. With the price of gold at its lowest in almost a year, analysts are already reporting a spike in demand. Policy measures introduced by the government have also played a part. Acting on a long-standing demand from jewellers’ associations, the import duty on gold and silver was cut recently, which has further brought down prices. The knock-off effect on making charges, pegged at 15%-20% of the market value of gold, is also likely to attract buyers.
On the other hand, gold ETFs are seeing a reversal in fortunes, with NAVs falling steadily from the record high seen close to a year ago. In 2020-21, ETF inflows quadrupled to Rs 6919 crore compared to the previous year. Now, with prices expected to fall further in the months to come, there is a bit of caution about buying ETFs. However, for long-term investors, gold ETFs may still be an attractive option as its performance over a period of time almost always makes up for any short-term losses.
The price of gold is inversely related to interest rate fluctuations in the international market. It is also influenced by geopolitical events, currency exchange rates, and bond yields. A good indicator for assessing the value of gold is the interest rates prevailing in the US. When the Federal Reserve cuts rates, the price of gold tends to increase, while any rise in interest rates invariably brings down gold prices. Look at these gold trends over 20 years and how to become a smart gold buyer.