Are gold loans going the microfinance way? - Views on News from Equitymaster

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Are gold loans going the microfinance way?

Mar 26, 2012

History is one of the best guides when it comes to lessons on investing. However, few investors read it adequately enough to avert future problems. Fewer make it a point to look out for similar signs of peril. In fact not just investors but even policy makers often fall prey to the tendency of economic risks repeating themselves.

The debacle of micro finance industry in Andhra Pradesh was initially seen by many as a one off case. Many opined that the likes of SKS Microfinance were mismanaged. Others blamed the regulator for policy overkill. However, that the risks were building up in the sector for years went unnoticed. At the time of IPO itself, investors seemed to be blinded by the triple digit growth rates. Double the industry margins did not seem odd despite the motive of lending to poorest of the poor. Most importantly, lending without collaterals and without sufficient NPA provisioning missed even the RBI's eyes for a very long time. Finally, when both NPAs and growth threw up negative surprises beyond comprehension, every stakeholder divorced himself from the sector. The PE and venture capital funds that had lined up at the doors of the MFIs too surrendered to the pessimism.

Meanwhile in the same geography and its neighbouring areas, another lending business flourished on the power of its collateral. That the collateral was a shiny metal called 'gold' assigned the loans an ever increasing value. The biggest players in the gold loan space too showed off triple digit growth rates to carry off successful debut on the bourses. Muthoot Finance and Manapuram Finance stood out as the leaders in the space despite banks and non banks together dishing out gold loans at the rate of 1,20,000 new loans a day! Each saw the ticket size of their gold loans rise around 7% more than the rise in gold prices in 2011. This means that the entities were not the only ones profiting from the trend in gold prices. Their borrowers too were making the most of the steady rise in value of the collateral.

However, thankfully the RBI was quicker in smelling the rot this time around. Unlike its peer in the US, the Reserve Bank Of India (RBI) is in no mood to allow borrowers to speculate on the basis of rise in value of collateral. The rise in loan to value ratio of gold loans was mooted precisely to curb this. The subprime housing bubble of 2008 came handy to remind the central bank of the downsides of excessive leverage.

We do not think the RBI has offered any hints of correction in gold prices with the precautionary mandate. That gold continues to remain a safe haven asset class is uncontested. However, overleveraging and speculative trends can be very painful for an economy in the long run.

Hence, we have several reasons to believe that gold loans are not going the microfinance way. One, unlike the latter, there is far more competition in gold loans with several PSU and private sector banks and NBFCs having joined in the fray. Thus, interest rates on the same are bound to remain competitive. With the RBI's strict vigilance, the quality of loans are also likely to remain untarnished. That too irrespective of the direction of gold prices in the near term. What is more, unlike the subprime home loans and microfinance loans, gold loans are of much shorter tenure (average 3 to 6 months). Because of this, any risk in asset quality becomes apparent before it is too late.

All said, investors need to take lessons from all such predicaments. Being extra vigilant and suspicious about supernormal growth rates and abnormally high profits does not hurt. It may lead to an error of omission of a worthy stock from your portfolio for a temporary period. However, it can be a great saviour for your portfolio in times of distress.

Tanushree Banerjee

Tanushree Banerjee (Research Analyst), is the editor of Stock Select and, ValuePro Equitymaster's oldest recommendation services. She is also the editor of Equitymaster's most popular newsletter read by over 300,000 subscribers, The 5 Minute WrapUp. Tanushree started her career at Equitymaster covering the banking and financial sector stocks and scrutinising RBI policies. Over the last decade, she developed Equitymaster's research processes that helped us pick out various multibaggers, across all sectors. A firm believer of "safety first" when it comes to investing, Tanushree closely follows the investing philosophies of Warren Buffett, Jeremy Grantham, and Joel Greenblatt.

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