6: Gold in the financial system

At over US$800bn,82 Indias private stock of gold is a significant

resource. In the late 1990s, the Government tried and failed
to draw some of this gold into the financial system. The latest
monetisation scheme proposal, however, could be successful.
Lowering the minimum deposit size from 500g to 30g is a
significant step forward and more households use banks now
than they did in the late 1990s. But only a modest amount has
been monetised and more still needs to be done. In contrast,
the gold loan market has flourished. In total, around 1,250t is
used as collateral, largely with informal lenders, such as
pawnbrokers. Since 2008, however, the formal sector has
developed, and banks and gold loan companies have grabbed
a share of the gold loans market.

Gold monetisation
Indias gold stock bigger than Apple
India has a huge stock of gold; some 23,00024,000t in
total, the majority of which is with households. And it is
incredibly valuable. Based on the 2015 average price it was
worth US$800bn. To put this in context, Apples market
capitalisation at the same time was around US$600bn;
two of Indias largest listed companies, Reliance Industries
and Tata Consultancy Services, were quoted at around
US$50bn each.
This scheme could be more successful, not least because
the minimum deposit size has been reduced to 30g, which
opens the scheme up to large swathes of the population.
In addition, there are more bank branches in India and
more households using banking services than there
were in 1999 when the GDS was launched. This should
make the marketing and distribution of gold monetisation
services easier for banks.
For the scheme to be a success, however, some hurdles
still need to be overcome. These include:

In the late 1990s, the Government tried to capitalise on
this gold to draw it out from households and into the
financial system with the launch of the Gold Deposit
Scheme (GDS). This allowed individuals to deposit gold at
banks in return for interest. In addition, the scheme was
exempt from capital gains, wealth and income tax.
But it did not work. Between 1999 and 2015 only around
15t was mobilised. The big stumbling block was the
minimum deposit, which at 500g, prevented many
individuals and households from accessing the scheme.
Gold monetisation v2.0
In the 2015 Union Budget, Finance Minister Arun Jaitley
announced plans for a new, updated monetisation
scheme, the structure of which is covered in detail in
Chapter 10.
Trust: It is vital that consumers, banks and jewellers
have trust in the quality of gold flowing around the
monetisation ecosystem
Ease of use: transactions must be simple. If they are
not, it is unlikely savers will deposit their gold at banks
Incentives: each market participant from the depositor
to the bank to the refiner must be incentivised to use
and develop the scheme
Infrastructure: it will take time for refineries, assayers
and banks to develop the infrastructure, processes and
products to meet customers needs.
If the mechanics of the scheme take these issues into
account, the chances of it being a success are increased.
If any one of these is not considered, the scheme
may struggle.

82 Approximate value as at end 2015.

Indias gold market: evolution and innovation 51

Gold loans
Growth of the gold loan industry
While the original GDS may not have been a success, the
gold loans market has boomed. Because of the emotional
connection with gold, people rarely sell. If they need
funds, most would rather pledge it as collateral and
secure a gold loan. This is a big market. It is likely that
around 1,250t of gold is pledged across the gold loan
industry in India.
There are two types of gold loan providers: formal (banks
and non-bank financial companies) and informal (money
lenders and pawnbrokers). Pledging gold as collateral has
been an ever-present feature of Indias gold market. For
generations, farming communities and rural households
have used gold as a means of financing, often pledging
it as collateral to raise funds to plant the following years
crops. This lending has mostly been informal; even now,
although there is no hard data available, the informal sector
probably accounts for around 6070% of the market.
The government, however, was uneasy with rural
communities being in debt to pawnbrokers and money
lenders, as well as being concerned about the extortionate
rates charged. In 2008, government agencies looked to
steer households away from the informal sector towards
the formal sector, including banks and non-bank financial
companies (NBFCs). Their efforts have met with some
success. For example, designating agricultural bank loans
as priority sector lending has supported the growth in
formal gold loans for such purposes.83 Consequently,
the State Bank of India now plays an important role in
providing gold loans in rural India.
In recent years, gold loans have become popular in the
cities as well as the rural areas. A key reason for this is that
gold loan rates compare favourably with those available on
personal loans.
These factors have supported the growth of the industry.
According to an RBI working group report,84 the gold loan
market was worth about Rs1.2tn in 2011 (US$25.5bn),
a six-fold rise in less than five years.85
83 Priority sector refers to those sectors of the economy that may not get timely and adequate credit in the absence of this special dispensation.
Typically, these are small value loans to farmers for agriculture and allied activities, micro and small enterprises, low income people for housing,
students for education and other low income groups and weaker sections.
84 Report of the Working Group to Study the Issues Related to Gold Imports and Gold Loans NBFCs in India, 6 February 2013.
85 Latest RBI estimate for the informal and formal gold loan market.
Indias gold market: evolution and innovation
But this growth has not been without challenges. After a
period of rapid expansion, the gold loan sector suffered
a setback during FY201314 as the market witnessed
several corporate failures. This led to fundamental
changes across the gold loan industry. In particular, a
loan to value (LTV) cap of 60% was applied to gold loans
offered by NBFCs. Gold prices also started to fall during
this period, which led to a significant decline in the level
of activity of NBFCs. NBFCs lost significant market share
to commercial banks (which did not have an LTV cap), as
well as to the unorganised sector. The trend was reversed
to some extent in 2015, when the LTV cap was revised
to 75%, levelling the playing field between NBFCs and
banks. During this phase, the gold loan NBFCs (Muthoot,
Muthoot FinCorp, and Manappuram) focused on
consolidating and stabilising their operations, while
the new NBFC entrants (Shriram City Union Finance,
Magma FinCorp, Capital First) reduced their exposure to
the segment.
For now, the era of regulatory uncertainty appears to have
passed and the gold loan NBFCs have been able to lay the
foundations for healthy growth over the coming few years.
Gold loan companies: drivers of growth
In the formal sector gold loans are provided by public
and private sector banks, Co operatives and gold loan
companies (NBFCs). While public banks have taken the
lead, the NBFCs have gained a sizeable share, capturing
almost 40% of the market in FY201415 (Chart 32).
Chart 32: Share of organised market in gold loan
against jewellery in FY2014-15 (%)
NBFCs 36%
Private sector banks 15%
Public sector banks 44%
Co operatives 5%
Source: Manappuram Finance; World Gold Council
38%
52
There is no official data on the amount of gold monetised
by gold loan companies. But an assessment of the
company reports of the two large southern India-based
gold loan companies Muthoot Finance and Manappuram
Finance reveals that in 2015 their combined gold
collateral totalled around 200t.86 Perhaps more important
than the amount of gold being pledged as collateral, is
how quickly these gold loan companies have developed
(Chart 33).
Their success is partly due to a stronger customer value
proposition than some of their competitors; they typically
process loans quickly. Banks, with a broad range of
financial products, have generally found it difficult to
compete with NBFCs, which focus on a narrow product
range. The success of these gold loan companies is
certainly not because of pricing; their interest rates are
significantly higher than banks, although much lower than
in the informal sector (Table 15).87

Table 15: Comparative analysis as at February 2016 88

Interest rates LTV
Banks Base rate + 2.5% to 5% Up to 80%
Gold loan companies 12% to 24% Up to 75%
Money lender/ 30% to 50% Depends on the amount
Pawn broker of loan and security

Source: Company websites; World Gold Council

Informal gold loan providers have a large market share.

Chart 33: Outstanding NBFC gold loans have grown rapidly since 2007
Rupees bn
700

600

Lower rates than the informal sector and better

500 customer service than the banking sector have
supported gold loan companies growth

400

300

200

100

0
2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15
Source: RBI; Manappuram Finance; Metals Focus

86 The gold loan industry is mostly centred in Southern India.

87 NBFC interest rates can vary between 15%25%, banks rates are typically base rate plus 24 percentage points,
while pawnbrokers and money lenders rates are typically 30%50%.
88 Company websites, Metals Focus.

Indias gold market: evolution and innovation 53

A low default rate is another factor underpinning gold
loan companies growth. Defaults typically hover around
1%2%.89 This is low compared with other loan products.
For example, nationwide non-performing loans account
for 4.3% of total Indian bank lending.90 A significant factor
here is that people are loathe to relinquish their gold. While
they are prepared to pledge it as collateral, they will often
want it back, especially if it is a piece of jewellery or an
ornament. Rising gold prices also made it quite lucrative
for borrowers to settle their debt and take receipt of their
gold. The corollary is that when the price falls, defaults
rise. In 2013, the default rate shot up to 3%. Still low
compared to other assets, but quite striking given the
usually lower default rates for gold loans.
Regulations for gold loan companies
By early 2011, the gold loan companies strength in this
market became an increasing cause for concern for the
RBI. The central bank was worried about their rapid
growth and the financial stability implications should gold
prices tumble.
The RBI took several steps to limit their presence in the
gold loan market:
In March 2012, priority sector lending was removed
from bank credit provided to gold loan companies.91
This pushed up their cost of financing
Later the same month, the RBI reduced the LTV gold
loan companies could offer from 75% to 60%92
In September 2013, they were only allowed to provide
a loan by cheque 93 for loan amounts above Rs1 lakh
(US$1,700) and they had to ensure they carried out full
due diligence on the borrower
Finally, NBFCs were required to provide RBI-approved
gold storage infrastructure.
These measures made writing new gold loans more
expensive and difficult: so the volume of business
dipped. But in 2014, after a period of lobbying, gold loan
companies succeeded in persuading the government
to restore the 75% LTV limit and business has since
recovered.94
89 Metals Focus, Company Reports.
90 World Bank.
91 https://rbi.org.in/Scripts/NotificationUser.aspx?Id=6248&Mode=0.
9 2 In 2014, after a period of lobbying, the RBI increased the LTV to 75%.
93 This was a move designed to encourage gold loan recipients to open bank accounts, if they did not already have them.
9 4 Muthoot Finance, Financial Results Q1 FY2016 presentation.
Indias gold market: evolution and innovation
Outlook
The outlook for gold monetisation is interesting. The flaws
associated with the first gold monetisation scheme most
significantly the minimum deposit size are not present
in the latest iteration and there are certain structural
developments that may help this latest scheme flourish.
First, there are more bank branches and more people
have bank accounts than they did when the first scheme
was launched.
Second, Indias infrastructure has improved. It has
an LBMA-accredited gold refinery, which can play an
important role in this scheme by promoting trust in the
gold flowing through the monetisation ecosystem. And the
launch of the Indian Gold Coin and the New Hallmarking
Act will provide a trusted gold product and standard for
use by the banking system.
But it still faces significant challenges. For the scheme
to be a success it needs to address the key issues we
have highlighted: trust, ease of use, incentives and
infrastructure. If any of these are overlooked, the
scheme may struggle.
It is important that realistic expectations are set. Despite
the significant stock of gold in India, our view is that
little of it will be monetised anytime soon. It will take
time to build the necessary infrastructure, for banks to
develop and market the right products, and for customers
to respond. Once that infrastructure is in place greater
volumes of gold can be monetised; we envisage up
to 25t being monetised within the next two to three years.
We expect gold loans to continue to play a significant role
in India, especially in rural communities. The make-up of
the sector will evolve as the government presses ahead
with its financial inclusion policies and the formal sector
plays a greater role. Money-lenders and pawnbrokers
could lose market share to banks and gold loan companies.
Within the formal sector, because of tighter regulations
governing gold loan companies, we can see a subtle shift
in favour of banks.
54