Gold financiers in a sweet spot: Muthoot, Manappuram can grow at 10-12% pa

The share price of Muthoot Fin has risen 31% over last year, but Manappuram underperformed with 9% return

One category of counter-cyclical businesses that can perform when an economy is not doing well is gold–backed lending. When households are financially stretched, they offer gold as security in traditional pawnbroking.  

Unlike other retail loans, gold-backed loans have near-zero default risk. There is a regulatory cap of loan-to-value of 75 per cent. Repayment schedules are short and the asset is easily auctioned if there’s an NPA. Gold loan NBFCs have historically been able to generate 25 per cent return on equity.

Many banks and NBFCs offer loans against gold. The RBI data says gold loans by banks rose 13 per cent YoY during April-August 2020, and 4 per cent YoY between April-August 2021. HDFC Bank and SBI have seen high growth.  The trend is similar for NBFCs. Muthoot Finance grew its loan book 27 per cent YoY in FY21; Manappuram Finance grew it 18 per cent in April-December 2020, before it was forced to auction large quantities. It auctioned gold worth Rs 1,500 crore in Q1FY22, also.

The past six years have seen 12 per cent CAGR in gold loans; only about 35 per cent is from the formal sector. But the market share of formal players is growing. Indian households hold $1.5 trillion of gold, according to The World Gold Council. About 10 per cent of this may be held as loan-security. Banks hold about 75 per cent market share in the formal gold loan business. The bulk of such bank loans are priority sector, taken by farmers for agricultural purposes.

Non-agri gold loans are higher yield (20-22 per cent) than priority sector gold loans (8-12 per cent). Three-four NBFCs are big players in the non-agri segment. The internal rate of return for banks is higher at 14-15 per cent than official yield since they charge various fees. Big players, such as Muthoot Finance, Manappuram Finance and Muthoot Fincorp, hold around 80 per cent market share in the NBFC gold loan segment. Every lender may face intense competition, due to the tempting combination of high yield and low risk. The account aggregator system may help banks grab market share.

The international price moved from $1,500 per ounce (about 65 gram) in January 2020 to a high of $2,031 in August 2020 and, it is around $1,740 now. Domestic price is linked to international price. But gold prices have an inverse relationship with $, being dollar-denominated. If $ weakens, gold gains. Higher gold prices may mean more AUM but the ratio of AUM doesn’t trend directly with prices. There are periods when gold AUM have risen while prices fell.

The high base effect may lead to moderation in growth. But it should be possible for NBFCs to grow at 10-12 per cent CAGR. Cost of financing should decline. NBFCs should be able to refinance interest costs down from 8-9 per cent to 7 per cent. Muthoot and Manappuram have external commercial borrowings of above 16 per cent of total borrowings. The NBFC growth model must incorporate two key steps: Expansion into north India, where formal lending has lower penetration, and allocating excess capital into profitable sectors. Only comparable yields are in the high-risk category of microfinance. The share price of Muthoot Fin has risen 31 per cent over last year, but Manappuram underperformed with 9 per cent return.