India Ratings and Research (Ind-Ra) estimates that auctions by non-bank financial companies (NBFCs) of gold lending would normalize in 4QFY22, as gold prices have stabilized since October 2021, after periods of corrections observed since December 2020, as well as a return to normal in business activities.
“However, in the face of intense competition from banks and the absence of similar spikes in gold prices, NBFCs, especially those with large portfolios, are likely to adopt aggressive strategies. to maintain and grow their gold lending franchise. Part of this would be reflected in compromising margins while offering low yield loans, especially large loans, to retain customers, incurring expenses higher operating costs and likely driving flexible lending terms, which impacts operating performance,” the ratings agency said.
Gold loan auctions by NBFCs increased in FY9MF22, possibly the highest since FY2014, when gold experienced greater price volatility. NBFCs offering gold loans faced higher bidding pressures in 9MFY22, largely due to the impact of COVID-19 on borrower cash flows and the correction in the price of gold by around 10% from mid-June to September 30, 2021. A similar decline was seen in 4QFY21, adding even more pressure in 1QFY22.
“Total stress would be even greater than the sum of this data, as not all defaults are auctions, with some successfully arranging payments. As borrowers of gold, especially small notes, are usually part of of the financially weaker segments, the auction data also indicates the high stress of these borrowers largely due to the pandemic.This is corroborated by the high delinquencies seen in microfinance loans in 9MFY22,” India Ratings said.
The sharp increase in defaults and auctions is a reminder that the performance of the asset class remains vulnerable to high volatility in gold loan prices and volatility in weak borrower income.
While NBFCs have seen a surge in loan auctions, the situation at banks has been less intense as regulation ensures that the loan-to-value (LTV) ratio remains lower throughout the life of the loans, providing an incentive more borrowers to arrange for repayment of gold loans from lenders.
Ind-Ra notes that the general practice among NBFCs funding gold loans is to limit the LTV ratio to 75% at disbursement and this cushion could shrink in the event of interest accumulation. However, banks are required to maintain an LTV of 75% over the life of the loans. In accordance with the respective internal risk policies, NBFCs largely send auction notices to borrowers if accrued interest + principal dues cause the LTV to increase to 90%-95%, thereby forcing borrowers to complete collateral or to close the loan. In the event of a shortfall in either case, the borrower’s collateral goes for an auction.
As gold prices appear to have stabilized and maintained current levels, Ind-Ra believes that auctions would stabilize towards the long-term average, barring any strong corrections. Also, a large chunk of bidding could mean that some weak borrowers would have been weeded out. In addition, the high liquidity of collateral and rapid liquidation ensures modest loss in the event of default for lenders. In most cases, the losses are limited to a portion of the interest. if only. However, the most important implication concerns the expansion of the loan portfolio.
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