RBI recently hiked the Loan to Value (LTV) for gold loans offered by Banks for non-agricultural use from 75% to 90% until March 2021. Loan-to-value (LTV) is the amount of loan that can be offered in proportion to the value of a collateral asset which is being kept as security. LTV of 90% would mean against an asset of Rs. 1,00,000 as security one can get Rs. 90,000 as loan.
Why the move?
So that low-income households and small businesses can raise loans easily by keeping their idle gold holdings as collateral. This is to reduce financial stress for them because of the slowdown caused by Covid Pandemic.
Many such borrowers use Gold loans as the last resort.
Why is this risky?
Gold prices have increased by 40% since the beginning of 2020 and are at all time high, there is a possibility of correction.
Let’s say a borrower has 100 Grams of gold and the price of Gold at the time of taking the loans is Rs. 55,000 per 10 grams. Then the value of Gold is Rs. 5,50,000. Borrowers under the new LTV norms can borrow upto 90% of value of collateral that is Rs. 4,95,000.
Note: Banks use the realizable value and not market price to calculate the value of the collateral. Here when we say market value, we are referring to realizable value.
In case the price of gold were to come down to let’s say Rs.40,000 per 10 grams, now the value of collateral has fallen to Rs. 4,00,000 and LTV at 90% is Rs. 3,60,000 against the earlier collateral value of Rs.5,50,000 and LTV at 90% which was Rs. 4,95,000.
Then to maintain an LTV of 90% the borrower will have to pay back the Bank around Rs.1,35,000. This might not be possible for a majority of already stressed borrowers.
This might result in increasing defaults.
During the Balance of Payments crisis of 2013, Gold Loans Non Banking Financial Companies (NBFCs) faced the issue of rising defaults as the gold prices corrected.
This time around RBI has allowed only Banks to offer Gold Loan LTVs of 90% and not NBFCs as Banks have a diversified portfolio of loans and are in a better position to handle a correction in gold prices in case if they were to happen.
It is to be seen if Banks will extend Gold Loans with LTV upto 90% given the rise in Gold prices. This looks like an ad-hoc short term move by RBI to make more credit available to low income households and small businesses. What we need is more permanent ways to ensure more credit can be made available at reasonable rates to the under served section.
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