Impact of falling gold prices on gold loan borrowers

Planning

oi-Sneha

By Sneha B K

Published: Tuesday, May 14, 2013, 10:32 [IST]

Falling gold loan prices bring broad smile on the face of Indians as they love buying gold and jewellery. It's also a reason to cheer for the government as the price fall will contribute towards reducing the current account deficit.

Reduction in current account deficit will be an indicator of strengthening economy and will boost the overall investor sentiments towards investment in stocks. It seems falling gold prices is good news for everyone. But there is a group of investors and borrowers who might not be happy. Which is that lot, and what's the reason of their concern?

Gold Loan Borrowers

Crashing gold price is putting pressure on cash flow and balance sheets of gold loan companies as their business model is tightly coupled with gold prices. If we try to understand the business of gold loan companies, in simple words, it can be said that they generate profit out of the interest payment they receive from borrowers.

These borrowers put gold/jewellery as collateral with the companies against which they receive loan. Once the collateral (Gold) price starts falling, there happens to be devaluation of the assets which the companies hold. In case of any default from the borrowers, the companies will have to sell gold which they hold in open market. As the prices in open market are less as compared to the price when the loan was originally sanctioned, it hampers the profitability of the company.

To avoid such situations, companies start pressurising the customers for prepayment or to increase the collateral. Both these situations are not borrower friendly as the borrower might not be in a position to make full payment or deposit extra collateral.

InvestmentYogi.com