With Retail Loans Reeling Under Pandemic Impact, Can Gold Loan Companies Like Muthoot, Manappuram Emerge As A Safe Investing Bet?

Retail loans, or loans given to individuals, were considered relatively safe bet for banks. In the previous decade, retail loans performed much better than corporate loans. Both private and public sector banks started focusing on retail loans. The share of retail loans outstanding for public sector banks went from 20 per cent in 2017 to 26 per cent in 2021. The share of retail loans outstanding for private banks went from 25 per cent to 29 per cent over the same period. Both simultaneously reduced their corporate exposure.

However, with lockdowns over the past year, the retail loan portfolios have not performed well. The retail income statement of multiple banks indicates that profits from the retail segment have fallen, quite possibly due to higher provisioning.

For instance, HDFC Bank’s net income from the retail banking space fell to Rs. 1090 crores from Rs. 2220 crores in the previous year in the first quarter.

For ICICI bank, retail banking income for the first quarter fell from Rs. 2758 crores to Rs. 389 crores.

Axis bank and Kotak Mahindra have reported net losses from the retail banking segment.

Bajaj Finance has converted around Rs. 10,000 crores of retail loans into flexi loans – which are usually considered disadvantageous for lenders. These results clearly show that the banks have been facing problems with their retail banking segment.

In the current scenario, gold loan companies offer a chance for investors to invest in the retail-lending space while keeping their capital safe. These companies give out loans to retail customers which are secured against the customer’s gold. The business began with moneylenders and pawn-brokers who dominated the business for decades. However, with the rise of gold loan companies, the sector has become organised and has ensured fair transactions for borrowers.

Firstly, the business model is extremely simple.

Unlike other lending segments, the gold loan segment does not require a deep analysis of customer data, intent to repay, credit history or credit scores. Even a customer with a bad credit score can avail a loan instantly provided they can deposit gold with the company. The process for availing a gold loan is quite simple – a simple Know-Your-Customer Check, the gold jewellery is assessed and the loan is disbursed. The lower documentation needs and lesser regulatory constraints lower the overhead costs for these companies along with a short turnaround time to disburse the loan. Banks that give out gold loans have relatively more paper work and might even require the borrower to open an account with the bank, resulting in a longer turnaround time.

Secondly, credit losses are quite unlikely.

The players’ loan-to-value (LTV) ratio is capped at 75 per cent. It means that a customer depositing gold worth Rs 100 can receive a loan of Rs 75 at most. The 25 per cent cushion offers a lot of comfort for gold loan players. Since the average loan tenure is four months, it is unlikely that gold prices will drop off by 25 per cent. Even then, Muthoot Finance lends at a LTV ratio lower than 70 per cent. In case the borrower defaults, the companies can sell off the gold and recover their principal along with interest.

Another advantage for these companies is that, in times of economic trouble, gold prices shoot up and it is an extremely liquid asset. Unlike other NBFCs which give out unsecured loans and are sensitive to adverse economic changes, Gold Loan(GL) companies have a very robust business model - even anti-fragile in certain situations. The anti-fragile nature of the business was visible when the business gained from the Covid-crisis when people began pledging their gold in order to avail loans.

Players like Muthoot and Manappuram have a strong brand recall. Though these players started out in south India, today, more than 51 per cent of Muthoot’s gold loan assets-under management comes from north India which shows the strong brand value Muthoot has managed to create.

The GL companies only value the gold and not the making charges. Further, by law, they can disburse only 75 per cent of the gold’s value as a loan. Gold ornaments hold sentimental value for the customers. Customers therefore prefer to deposit their gold with established players rather than unbranded lenders. Competing solely on the basis of interest rates is therefore difficult for unbranded or new players.

The scale of the largest businesses also aids brand-building exercises. With 4400+ and 3500+ branches respectively, Muthoot and Manappuram have built a huge network. To put this into context, much larger banks like ICICI and HDFC have around 5500+ branches. Therefore, it is economical and beneficial for large GL companies to take up brand-building exercises on a national scale. Smaller players in the business do not have these advantages of scale.

Lastly, GL companies have demonstrated competitive strength.

GL companies have continuously demonstrated their strength despite having faced problematic regulations for certain periods of time. For instance, during the 2012 to 2014 period, RBI regulations restricted lending by GL companies to 60 per cent of the gold’s value while banks could disburse upto 75 per cent of the gold’s value as loans. Customers began availing loans from banks as they were getting a better deal with banks. GL companies lost their market share. However, the RBI soon restored the lending capacity to 75 per cent for GL companies. The companies managed to return to their original market share levels, though the market had expanded during the period.

These companies also face competition from gold loan start-ups like Rupeek that offer doorstep gold loans. Rupeek, Indiagold and Ruptok are ambitious start-ups looking play a bigger role in the gold loan business. Rupeek has tied up with banks to use their branch networks to store gold.

Following these changes in the business model, Muthoot and Manappuram have established their own doorstep gold-loan businesses. It remains to be seen whether the start-ups or the incumbents can develop this into a profitable business. Incumbents, however, have an advantage with their brand power and network strength.

In the lending business, heavy competition can lead to lowering of lending standards resulting in a weak loan portfolio. With consumer/retail lending gaining favour with lenders, it is possible that lenders extended loans to riskier borrowers – resulting in higher provisioning.

Gold loan companies have emerged unscathed from the retail debt problem. Even with tough competition from banks and well-funded start-ups, GL companies have continued growing assets-under-management, revenues, profits and gold tonnage. However, currently the markets are attributing a large premium for high-quality NBFC companies, possibly making the sector frothy.

Gold-loan companies, with their safer loans, already command higher valuations than other lenders. Therefore, an investor must do their own due diligence on specific firms before investing.