Profitability of large gold loan non-banking finance companies (NBFCs) rebounded to peak levels seen before the regulatory tightening began in 2012 and eroded returns. FY2016/17 saw their return on assets zoom to over 4 per cent from around 2.5 per cent in FY2013/14.
The improvement started as large NBFCs made two changes to their business model in early 2014. One, they started a periodic collection of interest and second, they lowered product tenure.
Earlier, gold loans had a one-year tenure with a bullet repayment that included interest. Borrowers had the option to repay any time, and over 80 per cent of them did so within six months. However, in the past couple of years, forced by a decline in gold prices, lenders started to collect interest from borrowers at periodic intervals. It was reflected in balance sheets, and interest receivables fell to 3-4 per cent of assets under management (AUM) as on March 31, 2017, compared with the previous 6 per cent or so.
Periodic interest collection also ensured that the loan-to-value ratio remained intact and decline in gold price did not result in interest loss, which was the primary reason for declining profitability. It also reduced the chances of delinquency because a borrower's equity in pledged gold did not come down.
As for tenure, more loans are now disbursed for 3-9 months as against the earlier tenure of 12 months. It enables financiers to react swiftly to any decline in gold price.
Under the Reserve Bank of India's norms, gold pledged by delinquent borrowers can be auctioned only after the due regulatory procedure. Shorter maturity helps lenders do this sooner, if necessary.
Also, the interest accrued on loan spanning 3-6 months is less than that of 12 months. So, interest recovery, even through auction, has been higher. It is reflected in the 2-5 per cent increase in interest yields of financiers in FY2016/17 compared to FY2015/16 due to lower interest income reversals.
In July 2016, CRISIL had upgraded the ratings of two large gold loan NBFCs, factoring in the improved business model and profitability.
To be sure, a one-year loan with a provision to repay at any time and without periodic interest payment provided great flexibility and convenience to borrowers. The shorter tenure of products now takes some sheen off this aspect, which had earlier contributed to its popularity. Therefore, a fine balance between risk management and customer orientation is crucial to sustained growth in business and profitability.
In FY2016/2017, industry AUM grew 13 per cent compared to 5 per cent during FY2014/15 and FY2015/16. CRISIL expects the growth rate to remain moderate over the next couple of years.
While growth in the first half of the last fiscal was supported by favourable gold prices, the economic slowdown after demonetisation impacted businesses in the second half.
The overall share of NBFCs in the gold loan pie has increased by around 5 per cent over the past two fiscals as banks went slow.
With a focussed approach, faster turnaround time, established systems and processes, and widespread branch network, NBFCs are expected to maintain their niche in the segment. However, banks, with their cost advantage, will continue to retain two-thirds share of the gold loan market. On the other hand, efforts by large gold loan NBFCs to diversify into mortgage, microfinance and vehicle financing will help mitigate risks arising from their monoline business model.