India’s shadow banking industry is going through one of its worst-ever crisis. But there are some players in the sector who have emerged as outliers.
Non-banking financial companies (NBFCs) that give loans by taking gold as collateral are not only beating the economic downturn but are also growing at a scorching pace.
Two major gold loan financiers—Muthoot Finance and Manappuram Finance—reported stellar results in the March quarter. Subsequently, their stock prices sky-rocketed and are nearing their record highs.
Here’s what’s working in their favour:
All that glitters is gold
Even as India’s gross domestic product (GDP) is set to shrink for the first time in 40 years, the prices of gold, which are delinked to the economy, are at an all-time high.
This benefits gold loan financiers in two ways: Firstly, these NBFCs can lend more against gold as its value rises, and secondly, it provides a stronger margin of safety if a borrower defaults.
“Higher gold price improves monetisation of gold; borrowers would tend to increase their borrowings, especially due to lockdown-related challenges,” said a June 11 report by brokerage firm Kotak Institutional Equities.
In fact, analysts like Rusmik Oza of Kotak Securities stated that gold loans are a better alternative for small businesses and self-employed individuals in times of economic distress. “They will be able to avail credit against gold when very few financiers are willing to lend.”
A combination of these factors has led to a rise in the average gold loans per branch or office for these NBFCs.
Gold also works as a margin of safety or cushion. “The value of gold kept as collateral is higher than the loan amount. It means that even if a borrower defaults, these NBFCs can get back the money by auctioning the gold,” explained Oza. Also, as the price of gold continues to rise, the risk reduces.
This golden business model is also resulting in higher profits even in times of economic decline.
The primary reason for strong profitability is that these NBFCs don’t have to set aside money as much as other lenders in India for the impending surge of bad loans. Several lenders in India were forced to do provisioning for Covid-19 related expenses like bad loans, which dented their profits.
But India’s gold loan financiers don’t have any such headache as their gold reserve works as an insurance against defaults.
The management of Muthoot Finance in the latest investor call asserted that they don’t need to do any provisioning for Covid-19. The company has put aside Rs885 crore ($0.11 billion) as provisions, but that’s only as a “technical requirement,” it said.
Similarly, Manappuram Finance’s management said that they have set aside Rs55 crore for Covid-19 related expenses, which is merely 5% of their annual profits.
The managements’ confidence isn’t unfounded. The net non-performing assets (NPAs) or bad loans of Muthoot Finance and Manappuram Finance stand at just 0.9% and 0.5%, respectively. This is no mean task at a time when many non-gold NBFCs are folding up.
“One of the reasons for low NPAs is that the value of gold kept by a borrower as collateral is higher than the loan amount. So he or she obviously doesn’t want to lose it,” said Oza. Hence, there is a higher chance that a borrower would repay the loan. In addition, Indians attach sentimental value to gold, which increases the chances of repayment.