Why is RBI keeping an eye on gold loans? | Explained Premium

RBI tightens grip on NBFCs, mandates compliance with gold loan lending norms to prevent systemic risks and ensure sustainability.

The story so far: The Reserve Bank of India (RBI) earlier this month asked gold loan lenders to stick to regulatory norms while lending in a bid to tighten its grip over Non-Banking Financial Companies (NBFCs). The RBI has increased its scrutiny of NBFCs after it found certain NBFCs to be flouting regulatory norms. In March, the RBI banned IIFL Finance from issuing fresh gold loans after the firm was found violating lending norms.

The RBI stipulates lenders to comply with certain norms while lending money in lieu of gold. For instance, 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.

Also read: Ensure gold loans are repaid and not renewed, banks tell branches

And in order to comply with income tax rules, the RBI also mandates that when a loan is disbursed to a borrower, no more than ₹20,000 can be disbursed in the form of cash; 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.

It is believed that the RBI is working on detailed guidelines for gold loans that lenders will have to follow.

The RBI says it has found some NBFCs to be violating regulations linked to gold-based lending. IIFL Finance was disciplined in March for violating norms related to the size and form of loan disbursals, the evaluation and assaying of gold, the levying of charges, and irregularities in the auction process. For instance, the RBI found that there were loan-to-value irregularities in over two-thirds of defaulted accounts in the case of IIFL Finance.

It should be noted that NBFCs may want 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. To do this, NBFCs may try to deliberately overestimate the value of the gold that the borrowers submit as collateral. It is thus not surprising that the RBI has raised concerns about the way in which gold is assayed and valued by NBFCs.