The formal business of “loan against gold” is almost 11 years old now and most of us now have a fair understanding of the business drivers and the associated cyclicality. But it’s always useful to revisit these drivers before analyzing the current context. Below are the five most important drivers deposits!
1) Gold prices: The role of gold price is similar to that of “Vayu” or “wind”. Rising gold prices create tailwinds and falling gold prices create headwinds. Currently, we are in a period of benign/rising gold prices. When gold prices are on an upward trajectory, more people think about taking gold loans; the existing borrowers can get higher amount on the gold that they have already pledged. The lending companies get easy growth at no extra cost, leading to operating leverage benefits.
2) Competitive intensity: Like for all sectors, competition increases during good times and reduces in bad times. We saw that gold loan NBFCs couldn’t benefit much during the good times of 2021-23 due to price-war that ensued after the big entry of fintechs and banks. It is only now, after the regulator tightening the screws, that competition has subsided.
3) Regulation: Lending against gold has been a heavily regulated business for NBFCs since early 2014 and a lightly regulated business for banks until Sep’24. Beyond the vagaries of gold price fluctuation, the regulator has powers to slow down or accelerate the gold loan cycle. In the last six months, we have seen series of steps by RBI to slowdown the banks & selected NBFCs involved in gold loan business.
4)Unit economics: Gold loan happens at the branch and hence, is a high fixed-cost business. Branch productivity (AUM per branch) has a big role in determining your profits, which in turn determines your ability to offer loans at attractive interest rates as well as invest in people, process, marketing, etc. Some of the latest “AUM per branch” numbers are:
- a. Muthoot Finance = 16.7cr
- b. Muthoot Fincrop = 6.8cr
- c. Manappuram = 6.4cr
- d. IIFL = 5.0cr (down from 10.0cr+ due to RBI ban)
5) Systems & processes: Gold loan is an operationally intense business. Right from assessing the purity of gold, storage, ensuring part releases and renewals, collections, and auctions, there is huge volume of work that happens at branches. To ensure all this happens smoothly, significant management bandwidth is needed. New entrants including fintechs, large private & PSU banks have been recently been scolded by RBI for not having done a good job at this.
In our march’24 note, we wrote about the improving business cycle for gold loan NBFCs (https://greenedgewealth.com/gold-loan-NBFCs/index.html). The cycle has indeed gotten very strong, but with an exception of Muthoot Finance, most of the listed players have not been able to benefit from this. Let’s now focus on the reasons for this:
1) IIFL Finance: After a remarkable growth journey over 2021-23, IIFL was reprimanded by RBI for short-comings in its systems & processes. In the 7 months ban period when it was not able to disburse new loans, its gold loan book declined from peak of INR250bn to INR120bn. Now that RBI has lifted the ban of gold loans, IIFL is expected to reach its previous peak loan book somewhere in 2025, but it will be a while before the unit economics reach their previous peak.
2) CSB Bank: While the growth in its gold loan book have been decent, it has to fight a lot of other things – high operating costs associated with new retail strategy, deposit tightness, handicap of being present only in crowded South Indian market, limited branches, problems in corporate portfolio.
3) Manappuram: It lost a lot of market share between FY19-24 due to its inferior branch economics. From being the No.2 player in gold loans business in the last decade, it has slipped to No.4 now. While the company did show good growth in gold loans in the Jun’24 quarter, the losses in microfinance business had started mounting. Yesterday, RBI has found process deficiencies in the microfinance subsidiary and asked it to stop disbursing new loans.
While the company will likely bounce back from this over next few quarters, it will face some questions from its liability partners and this can probably slow down the growth in its core business i.e. gold loans. Stock is very cheap at 1x delivered book and there is immense scope of improving the per branch economics in this company. But that will require serious intent from the promoters and a big over-haul in the management.
4) PSU & Private Banks: They grew very fast between FY21-24, thanks to activating the product through their vast branch networks, indulging in high ticket & low-interest rate loans, using the PSL benefit despite unclear documentation, etc. Now that they are sitting on high base, they are realizing the difficulties in running a profitable gold loan business. Also, most banks have recently been scolded by RBI on process lapses, leading them to slow down.
5) Fintechs: The fintech craze is almost over and most of them find it difficult to borrow money at reasonable rates. Hence, they opted for co-lending model, where the fintech will act as the originator & servicer of the loan, but the loans would sit on the balance sheet of the banks. However, RBI has recently raised concerns on the processes being followed by them.
To summarize, the gold loan cycle is indeed alive and kicking! The growth is very much knocking on the doors of incumbents but most of them are not able to cater to it due to reasons relating to process or regulations. That leaves the public market investors with just one company at the moment i.e. Muthoot Finance. It has witnessed the best growth without sacrificing either its margins or its processes. It has also witnessed an improvement in its branch economics and hasn’t got any adverse observations from the last two rounds of RBI action.
That the other players are slowing down presents an even bigger opportunity for Muthoot Finance. It could be amongst the only 3 lending companies that has a chance to report growth & RoEs in excess of 20% (Lombard & Bajaj Finance being the other two)! Muthoot Fincorp too is showing promising trends like stable pricing and improved branch economics, but that’s an unlisted company.
Our previous notes on the topic:
- Mar’24: https://greenedgewealth.com/gold-loan-NBFCs/index.html
- Nov’23: https://greenedgewealth.com/gold-time-to-rise-shine/index.html
- Apr’22: https://greenedgewealth.com/gold-price-gold-loan-nbfcs-is-the-correlation- breaking-down/index.html
Note: Greenedge Wealth Services LLP is SEBI registered investment advisor. However, the above article has been written for educational purpose and should never be construed as an investment advice. The readers are requested to do their own due diligence.