For India’s gold loan companies, the message is clear, forewarned is forearmed

By VP Nandakumar

Among India’s gold loan companies, it was long an axiom that lending against household gold jewellery is less risky than lending against other commodities because borrowers are emotionally attached to their gold.

Default was considered unlikely even if gold prices fall because the sentimental value of the ornament to the borrower would outweigh its market value. The validity of this assumption was put to severe test in April 2013 when gold prices crashed by 15 percent in two trading sessions, and continued to trend lower thereafter.

As we now know, there was indeed an increase in defaults to the extent that profitability of gold loan NBFCs was severely dented. However, it was not quite mayhem and the business did not lapse into losses either. The episode poses some questions. Is India’s attitude to gold changing? Are we becoming less sentimental and more realistic the way we see gold? A recent study offers a good insight.

Changing attitudes

In December 2014, FICCI released the findings of its study seeking effective ways to monetise India’s gold. The report “Why India needs a Gold Policy” was based on an extensive survey of 5000 people in 33 cities across India. Respondents were also asked a set of questions to assess their sentiment towards gold.

When asked to rank the assets they would liquidate in a crisis, their first choice was, not surprisingly, bank deposits. The second choice, gold jewellery, was a revelation. Questioned further, many indicated they would sell the large items of jewellery first because they considered ancestral jewellery to be old-fashioned and not wearable.

As the report infers, “This suggests that attachment to such pieces may not be as sticky or comprehensive as is widely believed.”

How did this change come about? With the benefit of hindsight, I can think of two main reasons.

Overcoming taboos, the flip side

For long, the business of gold loans business was weighed down by this widespread taboo against pledging family gold. Did the taboo endure precisely because emotional attachment makes the idea of parting with one’s cherished gold distasteful? Consider the recent developments.

Over the last half decade, gold loan companies went into an advertising overdrive to urge people to shed inhibitions and embrace gold loans. The campaign has had a measure of success in reshaping attitudes. And that gives rise to a paradox.

This success comes with the unintended consequence that, along with shedding of taboos, there was also erosion in the age-old attachment to gold. After all, when something is not taboo, you become more casual about it. Success in undermining taboos comes at the cost of weakening the emotional connect.

As hedge against inflation

Over the last decade, the economy was in the grip of high inflation. Return on bank deposits was lower than consumer inflation. Coincidentally, it was also a time of relentless appreciation in the price of gold. The practical outcome was that many were pushed into buying gold in increasing quantities merely to safeguard their savings against inflation. Money, earlier parked in bank deposits, now find its way into jewellery.

Logically, this “investor class" has little sentimental connect with the jewellery, seeing it with the same detachment as any other liquid investment like bank deposits or equity shares. Unlike traditional borrowers, this lot was always primed to default in the event of fall in price of gold.

And so, as gold loans move up the value chain from a distress to a lifestyle product, it will become increasingly difficult to distinguish it from other commodity lending. Perhaps this is the price paid when a niche business is scaled up for the mass market. Weigh the benefits against costs, however, and the trade-off is still worthwhile. All the same, for India’s gold loan companies, the message is clear, forewarned is forearmed.

The author is MD & CEO of Manappuram Finance Ltd. Views are personal