MUMBAI: The Reserve Bank’s draft regulatory enhancements for gold-backed loans offer greater clarity to market participants, which should reduce regulatory uncertainty and variability in lender compliance, though some changes may raise operational complexities for lenders, but large companies with adequate resources should be able to navigate them, says rating agency Fitch Ratings India in its latest report.
The new draft follows earlier observations of the Reserve Bank on irregular gold lending practices, released in September 2024, and introduces provisions on customer notification and reimbursement procedures to strengthen customer protection. Broader disclosures will also improve market transparency on lenders’ gold-backed loan performance.
According to Siddharth Goel, a director for non-banking financial institutions ratings at Fitch, the key enhancements in the norms, which RBI says are aimed at harmonising the lending norms for all players, include linking borrower repayment capacity to the approved loan amount and providing more guidance on regulatory loan-to-value (LTV) calculations.
“Both these measures raise the bar for lenders, but we believe larger gold-loan specialists such as Muthoot Finance and Manappuram Finance should be able to adjust to the new requirements. These proposals also allow existing industry practices, such as top-up gold-backed loans and renewal loans, subject to conditions that broadly align with current norms,’ he said.
The new rules will supersede a raft of earlier directives on the product, while key regulations for non-banks issued in 2013 and 2014 requiring RBI approval for new branch openings for lenders with over 1,000 branches remain unchanged, he said.
Pureplay gold loan companies primarily extend loans based on the collateral value now but with new rules may necessitate additional procedures to assess borrower income, prolonging loan turnaround time and increasing operational expenses. Lenders may be able to introduce underwriting measures to meet the proposed requirements for individual consumption loans, but such assessments may be imprecise for rural and semi-urban customers, who generally have variable earnings.
The draft rules also require lenders to conduct business cash flow assessments for income-generating gold-backed loans. We believe non-banks are less likely to offer such loans, as the underwriting process may be too cumbersome. The draft rules do not specify whether non-banks’ loans to sole proprietors for working capital will be classified as income-generating loans, but if so, this can significantly slow an important source of credit to the rural economy.
The regulations propose that the LTV limit (75% for non-banks) will apply throughout the loan tenor, not just at the time of origination, and the ratio for bullet-repayment gold loans must include the total amount due at maturity, including interest for the full loan tenor. This strengthens the financial buffer against adverse gold price fluctuations.
However, the requirement would lower the effective LTV at origination, potentially reducing the product's attractiveness to borrowers. To mitigate the effects, non-banks may adjust their lending structures by offering shorter-tenor bullet repayment loans or amoritising repayments. Such changes would require adjustment in customer behaviour and could prompt rising delinquencies if borrowers take longer to adapt.
The RBI also wants lenders to set aside a 1% provisioning charge on loans breaching LTV limits. This acknowledges that it can be difficult to rectify LTV breaches through collateral calls or repayment notices when gold prices decline. The amount is also manageable relative to net interest margin, but the measure will make credit costs and profitability more sensitive to collateral price falls, he warned.