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History so far: Earlier this month, the Reserve Bank of India (RBI) asked gold lenders to follow regulatory norms while dispensing loans, in an attempt to tighten its grip on non-banking finance companies (NBFCs). The RBI has stepped up scrutiny of NBFCs after it found that some NBFCs were violating regulatory norms. In March, the RBI banned IIFL Finance from issuing novel gold loans after the company was found violating lending norms.
What are the RBI gold loan norms?
The RBI makes it mandatory for lenders to follow certain norms while lending money instead of gold. For example, lenders are prohibited from lending any amount exceeding 75% of the value of the gold presented as security by the borrower. This is intended to give banks enough of a cushion to cover any losses by selling gold in the event that a borrower fails to repay the loan.
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To comply with income tax regulations, the RBI also requires that when a loan is disbursed, the borrower cannot withdraw more than ₹20,000 in cash; the remaining loan amount must be transferred to the borrower’s bank account. It also instructs lenders to conduct gold auction (in the event of borrower default) in a fair and clear manner at locations available to borrowers.
The RBI is believed to be working on detailed guidelines for gold loans, which lenders will have to follow.
Why does the RBI want to strengthen these norms now?
The RBI says it has found some NBFCs violating regulations related to gold-based lending. In March, IIFL Finance was disciplined for violating standards regarding the size and form of loan disbursements, valuation and marking of gold, collection of fees and irregularities in the auction process. For example, the RBI found that in the case of IIFL Finance, there were loan irregularities in more than two-thirds of the defaulted accounts.
It is essential to note that NBFCs may want to augment the size of their loan book at an aggressive pace in an attempt to grow their business and therefore may be willing to offer loans of more than 75% of the value of the underlying collateral. To this end, NBFCs may try to deliberately inflate the value of gold presented by borrowers as collateral. It is therefore not surprising that the RBI has raised concerns about the way gold is assessed and valued by NBFCs.
Lenders such as IIFL Finance used internal auditors to assess the value and purity of gold offered as security by borrowers. This is in contrast to gold loans from banks, where external appraisers determine the value and purity of the gold. It is essential to note that the NBFC’s gold loan book has been growing at an aggressive pace since the pandemic, more than quadrupling from around ₹35,000 crore at the end of FY20 to around ₹1,31,000 crore at the end of FY2023.
The RBI may be concerned that such aggressive lending by NBFCs is a widespread violation of lending norms and that it could potentially create systemic problems in the future as the gold lending industry grows rapidly.
How will the RBI audit impact NBFCs?
NBFCs expect the RBI’s scrutiny of their lending practices to impact their growth and profitability. For example, the RBI’s insistence that no more than ₹20,000 should be disbursed in cash after loan approval is expected to make NBFC gold loans less attractive.
Unlike banks, NBFCs take pride in offering short-term emergency cash to borrowers, especially those who are not part of the banking system and mainly deal in cash. Many NBFCs may also have to become less aggressive in their lending practices as the RBI enforces loan-to-value rules more stringently.
It is to be noted that the RBI has temporarily allowed lenders to lend up to 90% of the value of the underlying gold collateral during the pandemic to assist borrowers, which has also helped NBFCs aggressively augment their loan book.
Moreover, measures to make the auction process more clear and accessible to borrowers could augment the cost of doing business for NBFCs and lead to higher lending rates for lenders. On the other hand, the RBI may believe that its lending norms will make the gold lending business more sustainable and assist avoid systemic risks in the long run.
