To strengthen its control over Non-Banking Financial Companies (NBFCs), the Reserve Bank of India (RBI) has requested that gold loan lenders adhere to regulatory standards when making loans. After discovering that some NBFCs were breaking regulatory rules, the RBI has tightened its examination of NBFCs. After discovering that IIFL Finance had broken lending guidelines, the RBI prohibited the company from making more gold loans in March.
What rules govern gold loans by the RBI?
The RBI requires lenders to adhere to specific standards when lending money in lieu of gold. For example, lenders are prohibited from lending more than 75% of the gold worth that the borrower submits as security. This is to ensure that banks will have enough capital to cover any losses from the sale of the gold in the event that the borrower defaults on the loan.
Additionally, the RBI stipulates that when a loan is granted to a borrower, no more than ₹20,000 can be distributed in cash; the remaining loan amount must be placed in the borrower’s bank account to comply with income tax regulations. Additionally, it directs lenders to hold an open, transparent, and equitable auction of any gold in the event that a borrower defaults at a place that is easily accessible to the borrowers. The RBI is developing comprehensive rules for gold loans that lenders must abide by.
Why does the RBI wish to reaffirm the standards?
The RBI has found certain NBFCs to violate rules about lending based on gold. IIFL Finance was penalized in March for breaking the rules concerning the quantity and format of loans disbursed, the assessment and analysis of gold, the imposition of fees, and anomalies in the auction procedure.
NBFCs may be willing to offer loans worth more than 75% of the value of the underlying collateral since they may desire to develop their business by aggressively expanding the size of their loan book. NBFCs may attempt to accomplish this by purposefully inflating the value of the gold that the borrowers provide as security. Therefore, it is not unexpected that the RBI has expressed concerns regarding the methods used by NBFCs to assay and value gold.
Lenders like IIFL Finance used internal assayers to assess the purity and worth of the gold that borrowers had pledged as collateral. In contrast, external assayers determine the value and purity of the gold used in bank-extended gold loans. Notably, since the pandemic, NBFCs’ gold loan portfolio has increased, more than quadrupling to around ₹1,31,000 crore by the end of FY 2023.
The RBI may worry that, as the gold loan market expands quickly, NBFCs’ aggressive lending practices are a widespread breach of lending standards and could eventually lead to systemic problems.
How are NBFCs affected by RBI scrutiny?
The NBFCs anticipate that the RBI’s examination of their lending practices will impact their expansion and profitability. For example, it is expected that the RBI’s insistence that, upon loan approval, no more than ₹20,000 will be given as cash may reduce the appeal of NBFC gold loans.
Unlike banks, the NBFCs take pride in providing borrowers with emergency cash on short notice, especially those that predominantly transact in cash and are not affiliated with a bank. To assist borrowers during the pandemic, the RBI temporarily permitted lenders to extend loans up to 90% of the value of the underlying gold collateral. This helped NBFCs rapidly grow their loan books.
Moreover, efforts to improve the auction process’ accessibility and transparency may raise NBFC operating expenses and push up lending rates for lenders. On the other hand, the RBI might think that by enforcing its lending guidelines, the gold loan industry will become more resilient over time and help prevent systemic problems.
