The euphoria over rise in gold prices over past few years had not just caught on with buyers and investors. Companies offering loans against gold had also gone overboard in a bid to capitalize on the trend. Not just specialized gold financing companies, but even banks became big ticket gold loan providers. However, the subsequent correction in gold prices impacted the gold loan providers by eroding the value of their collateral.
Another segment that has been impacted by the rise in demand for gold is the gold leasing segment. Bullion banks and central banks lend out physical gold to institutional investors and manufacturers. The borrowing rates on such gold have been near historically low levels over the past four years due to plentiful supplies. However, the government's recent ban on gold imports and dwindling physical supplies has taken the borrowing rates to highest levels since 2009.
In fact the shortage of physical gold has also brought speculators into the fray. Speculators are now borrowing physical bullion and then selling it to jewelry manufacturers and institutional investors.
The government's disapproval of gold purchase and gold investments is therefore not having the desired effect on the economy. It may have led to a temporary fall in import bills. But the same seems to have come at the cost of speculative tendencies in financing against gold.
The Reserve Bank of India has also expressed concern over the risk exposure of banks and NBFCs towards gold loans. In fact, recently the gold financing companies have witnessed significant pressure due to the fall in loan to value ratio. For example, Manapurram Finance and Muthoot Finance are facing rough weather on back of write offs.
As an industry gold loans cannot be compared to high risk exposure ones like microfinance or equipment finance. However, speculative tendencies over the value of collateral can, not just create a bubble, but also hurt the fundamentals of key players in the sector.