Gold loans: Govt focus right on getting more liquidity to the people

True that the lender would now have a smaller buffer in case of a fall in the value of gold kept as collateral. But that's a calculated risk

Indians are obsessed with gold. They want to possess as much as they can for both economic and cultural reasons. This annoys economists and governments who think it is a dead asset. So they are constantly trying to take away people’s gold through one strategy or another.
 
This is why the Reserve Bank of India (RBI) governor on Thursday announced that the central bank would now allow banks (and not non-banking financial companies) to give gold loans worth up to 90 per cent of the value of the gold being put up as collateral by the borrower. The earlier limit was 75 per cent.

This move has been received positively by some but criticised by others. So, here’s a more detailed look at the move and what it means:
 
What happened?
 
Along with communicating the Monetary Policy Committee’s decisions regarding the repo and reverse repo rates, the RBI Governor also announced a set of additional developmental and regulatory measures to ease the stress caused by Covid-19 and the lockdown.
 
One of the measures announced was an increase in the permissible loan-to-value (LTV) ratio for loans against a pledge of gold ornaments and jewellery for non-agricultural purposes from 75 per cent to 90 per cent. This relaxation will be available till March 31, 2021.
 
The result of this move will be quite simple: You will get a larger loan from the bank for the same amount of gold you put up as collateral. For example, where earlier gold worth Rs 1,000 would have got you a maximum loan of Rs 750, you will now get Rs 900.

Why do this?
 
The bulk of the decisions in the Aatmanirbhar Bharat package were aimed at keeping companies, both large and small, afloat. The decisions aimed at individuals were more in the nature of emergency transfers of cash and food to those who needed it. That emergency imperative seems to have passed, replaced instead by the need for more medium-term sustainability measures.
 
There was also the need to support the large number of consultants and self-employed people in the country who had been left without any viable income.
 
The first step in this policy direction change was the finance minister’s recent announcement that the Rs 3-trillion Emergency Credit Line Guarantee Scheme for MSMEs (announced in the Aatmanirbhar Bharat package) would now be applicable to individuals as well.
 
Thursday’s relaxation, when it comes to gold loans, is another step in the same direction – providing more liquidity to individuals.
 
The price of gold has increased nearly 40 per cent in the past six months, so it’s a good time to implement such a relaxation. Not only will people get a larger loan for the same quantity of gold because of the increase in gold prices, but that loan amount will now be even higher because of the relaxation in limits. Given that gold loans can be provided by banks as well as NBFCs, they are also a widely accessible credit-enhancement tool.

Are there any negative effects?
 
Banks were earlier given a buffer of 25 per cent of the value of gold so that they could hedge against a possible fall in the price of gold. Let’s go back to the example used above. Let’s say that the price of gold falls such that the gold collateral you gave to the bank is now valued at Rs 900 instead of Rs 1,000. Prior to this relaxation, this value would still have been higher than the maximum loan amount of Rs 750, which is a comfortable buffer in case of a default.
 
Now, after the relaxation, the bank would not have any buffer in such a scenario. While this is a risk, it is a calculated one. The government has time and again shown that it stands ready to support banks and NBFCs in trouble, so that’s less of a worry. The focus instead has rightly been on getting more liquidity to the people.