Why Gold Loan Companies Face A Sudden Lending Risk?

Following Covid-19, gold loans have become extremely popular and there is a sudden surge in loans against gold. The reasons are simple - it takes just about 15 minutes to get a gold loan credited into your account or cash as the case maybe. Given joblessness and a cut in salaries, this has become an easy and preferred option.

The Reserve Bank of India recently raised the loan to value limit against gold loans to 90 per cent. This means that if your gold is worth Rs 1 lakh, you can avail a gold loan of as much as Rs 90,000.

The big risk that gold loan companies face

Banks lending money against gold and gold loan companies like Muthoot Finance and Manappuram Finance, facing a risk here. Earlier this week, gold prices plunged by a whopping 5 to 6 per cent on a single trading day. So, if it sees dramatic falls like this, customers would prefer not paying back their loans, as their pledged gold value would be below the loan value.

Let's cite an example. If you pledged gold worth Rs 2 lakhs, as per the present RBI guidelines, you can avail a loan of Rs 1.8 lakhs. If there is a sudden collapse in prices below the Rs 1.8 lakhs mark, individuals would prefer not paying back the loan. The RBI has cut it too fine, by allowing the loan to value at 90 per cent. Given that gold is at historic high of nearly Rs 54,000, a sudden fall is possible now than ever before. Perhaps, the idea is that it could help to kick-start the economy as this is the fastest and easiest loan to avail.

It's important to remember that in 2008, when there was a sub prime mortgage crisis in the US, and real estate prices crashed, individuals preferred returning their mortgaged house keys to the bank, rather than going ahead and paying the loan. It's highly possible here too, if gold prices crash. However, one will have to wait and watch to see how gold prices move in the future. Currently, prices have dipped from peak levels and there is room for a further downside as well, which is likely to cause some anxiety to banks and gold loan companies.