Gold loans, which are granted against a pledge of gold ornaments and jewellery, have come under the RBI’s scrutiny as they defy the lending norms of other assets and often fail to contribute to overall growth.

The review, as well as the findings of the onsite examination of select supervised entities by the RBI, indicated several irregular practices in this activity. The major deficiencies include shortcomings in the use of third parties for sourcing and appraisal of loans, valuation of gold without the presence of the customer, inadequate due diligence, and lack of end-use monitoring of gold loans.

RBI’s Advisory Too Late?

The RBI has pointed out the lack of transparency during the auction of gold ornaments and jewellery on default by the customer, weaknesses in monitoring of loan-to-value, and incorrect application of risk-factors, among others. These irregularities were observed across various supervised entities, including commercial banks, small finance banks, urban cooperative banks, and non-banking financial companies (NBFCs).

In response to these findings, the RBI has advised lenders to comprehensively review their policies, processes, and practices on gold loans to identify gaps and initiate appropriate remedial measures in a timebound manner. The central bank has also emphasized the need for close monitoring of gold loan portfolios, especially in light of significant growth in the portfolios in certain entities.

The RBI’s directive also highlighted the need for entities to ensure that adequate controls are in place over outsourced activities and third-party service providers. The central bank has warned that non-compliance with regulatory guidelines will be viewed seriously and will attract supervisory action by the RBI.

Impact on the Gold Loan Sector

This warning on gold loan practices follows a similar caution issued by the RBI in August 2024, highlighting issues with home equity or top-up housing loans such as non-adherence to loan-to-value (LTV) ratios and lack of end-use monitoring. The RBI Governor, Shaktikanta Das, had then noted that such loans may lead to funds being deployed in unproductive segments or for speculative purposes.

The RBI’s advisory to gold lenders also highlighted several specific cases of irregularities or deficiencies with respect to gold loans being granted. These included instances where gold loans were given through partnerships with fintechs and business correspondents (BCs), and practices such as valuation of gold being carried out in the absence of the customer, credit appraisal and valuations being done by the BC itself, and gold being stored in the custody of BC.

The review also revealed a lack of a robust system for periodical LTV (loan-to-value) monitoring with instances of breach of regulatory LTV ceilings observed in some entities. In other instances, the application of risk weights was at variance with the prudential regulations. The end use of funds was also usually not verified for non-agriculture loans and there was a lack of proof or proper documentation obtained and retained in respect of agriculture gold loans.

The RBI’s directive has likely led to a negative impact on the share prices of major gold financing companies, as indicated by mentions of stocks slipping for companies like Muthoot Finance and Manappuram Finance. These companies would have to review and potentially tighten their practices, which could involve increased costs and possibly affect their short-term business operations. The directive also suggests increased regulatory scrutiny, which might lead to a more cautious approach by investors in the sector.

Otherwise, the RBI’s directive serves as a wake-up call for gold lenders to tighten their practices, lest the RBI may tighten the rules to  maintain the stability of the financial system. Certainly, the directive is going to impact on gold loans segment of many banks and NBFCs.

Gold as Crisis Saver

Whether Covid-19 or Forex crisis, over the period gold remained the single instrument to save the nations to sustain and India stands to benefit from the gold as a reserve, as the case with many other central banks across the globe. From a low of 7% seen in CY20, the share has improved significantly to 26% at present.

As per World Gold Council report, Central Bank of Turkey was the largest buyer, followed by People’s Bank of China and Reserve Bank of India. This may be on account of attaching greater weight to gold’s value in crisis response, diversification of portfolio and credibility on account of store-of-value. But the value erodes when the asset changes hands from the owners to the lenders. Here, the RBI is quite cautious.