Why is the RBI keeping an eye on gold loans?
- May 19, 2024
- Posted by: OptimizeIAS Team
- Category: DPN Topics
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Why is the RBI keeping an eye on gold loans?
Sub: Economy
Sec: Monetary Policy
Context:
- The Reserve Bank of India (RBI) had asked gold loan lenders to stick to regulatory norms while lending in a bid to tighten its grip over Non-Banking Financial Companies (NBFCs).
More on news:
- The RBI has increased its scrutiny of NBFCs after it found certain NBFCs to be flouting regulatory norms.
- RBI banned IIFL Finance from issuing fresh gold loans after the firm was found violating lending norms.
- Gold loan portfolio of NBFCs has increased at an aggressive pace since the pandemic, growing over four fold from about ₹35,000 crore at the end of financial year 2020 to about ₹1,31,000 crore by the end of FY 2023.
- RBI had temporarily allowed lenders to make loans up to 90% of the value of the underlying gold collateral during the pandemic to help borrowers, and this also helped NBFCs expand their loan books aggressively.
What are the RBI’s gold loan norms?
- The RBI stipulates lenders to comply with certain norms while lending money in lieu of gold.
- Lenders are not allowed to lend any amount of money that is greater than 75% of the value of the gold that is submitted as collateral by the borrower.
- This is to ensure that banks have sufficient cushion to absorb any losses by selling the gold in case the borrower defaults on the loan.
- Complying with income tax rules, the RBI mandated that when a loan is disbursed to a borrower, no more than ₹20,000 can be disbursed in the form of cash and the remaining loan amount needs to be deposited in the borrower’s bank account.
- It also instructs lenders to conduct the auction of any gold (in case a borrower defaults) in a fair and transparent manner in locations that are accessible to the borrowers.
Why does the RBI want to reinforce these norms now?
- Some NBFCs are violating regulations linked to gold-based lending.
- RBI found that there were loan-to-value irregularities in over two-thirds of defaulted accounts in the case of IIFL Finance.
- NBFCs are wanting to increase the size of their loan book at an aggressive pace in an attempt to grow their business, and thus may be willing to offer loans of value that exceed 75% of the value of the underlying collateral.
- RBI suspects that aggressive lending by NBFCs is leading to widespread violation of lending norms and that could potentially cause systemic trouble in the future as the gold loan industry grows in size rapidly.
- NBFCs are trying to deliberately overestimate the value of the gold that the borrowers submit as collateral.
- Lenders such as IIFL Finance were using internal assayers to evaluate the value and the purity of the gold offered as collateral by borrowers.
Impact on NBFCs?
- RBI’s scrutiny is expected to make NBFC gold loans less attractive.
- NBFCs might become less aggressive in their lending practices as the RBI enforces the loan-to-value rules more strictly.
- Such measures to make the auction process more transparent and accessible to borrowers could increase the cost of doing business for NBFCs and lead to higher borrowing rates for lenders.
- These lending norms will make the gold loan business more sustainable and help avoid systemic risks in the long run.
What are NBFCs?
- Nonbank financial companies (NBFCs), also known as nonbank financial institutions (NBFIs), are entities that provide similar services to a bank but do not hold a banking license.
- A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956.
- Investment banks, mortgage lenders, money market funds, insurance companies, hedge funds, private equity funds, and P2P lenders are all examples of NBFCs.
Features of NBFCs:
- NBFC cannot accept demand deposits.
- NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself.
- Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs.