During the covid-19 pandemic, many borrowers resorted to gold loans to fund their cash requirements. The rise in prices of the yellow metal helped borrowers get a higher amount of loan for the same amount of gold. However, recently we saw the gold prices correct sharply.
The commodity has corrected by ₹4,400 per 10 grams or around 8% in the past one month as per the price published by Indian Bullion Jewellers Association.
Correction in gold prices will certainly reduce the amount a person can borrow, but for existing borrowers, it will also mean that the lender may ask them to make a part prepayment of the loan amount in case the gold prices correct substantially.
“These are demand loans where we can ask the customer to make full or part-prepayment at any point in time. So in case, there is a correction in gold prices and as a result, the loan-to-value ratio (LTV) goes up, then there is a clause in the agreement that allows us to ask the customer to make a part payment or provide additional collateral to bring the LTV to the desirable level,” said Mohan K, vice-president and country head – agri, micro and rural banking at Federal Bank.
“To arrive at the gold value, we take the past one month moving average or current price, whichever is lower. So, it takes care of the short-term fluctuations,” said Mohan.
LTV is basically the percentage of loan amount given against the value of gold put as collateral with the lender.
For example, if the value of gold ascertained by the bank is ₹1 lakh and the bank has given a loan of ₹80,000, then the LTV of the loan will be 80%. If the value of gold falls to ₹90,000 due to correction in gold prices, the LTV will go up to 88.88%. So in this case, the bank may ask the borrower to make a part prepayment or provide additional collateral to bring the LTV at the earlier level. It will depend on various factors, including the customer’s relationship with the bank or tenure of the loan remaining.
“Normally we do not ask the customers to prepay the loan, as we keep enough margins while giving the loan. However, we reserve our right to recall the loan in case of any extraordinary fall in prices. Gold prices have seen fluctuations but as these are short-term loans ranging between three-four months, we have never faced the situation to exercise this option,” said George Alexander Muthoot, managing director, Muthoot Finance Ltd.
Also, the Reserve Bank of India (RBI) has allowed an LTV of 90% on gold loans for banks while for non-banking finance companies it is at 75%. So, in case the LTV exceeds this limit, the lender can ask for a prepayment.
“In some cases where the loans have been booked at high LTV, the lender may make a cash call asking the borrower to make partial prepayment so that the LTV stays within norms,” said Gaurav Gupta, CEO, MyLoanCare.
As higher LTV means higher risk for lenders, they generally limit it to lower levels. “So, the maximum LTV we provide is 85% that too on short-term loans. For higher tenure loans, we limit the LTV to 75%,” said Mohan.
Fall in prices will have two implications for the lenders. “First, the lenders will need to carefully monitor their asset coverage and make margins call on all customers whose asset cover has fallen below norms due to fall in prices. Second, lenders may need to review their risk and product policy and decide to set the LTV at lower levels in case they expect a further drop in gold prices,” said Gupta.
For new borrowers, a correction in the price of the yellow metal would mean they can borrower a lower amount.
“New borrowers may face a double whammy in the form of the lower loan amounts. The borrower would get a lower loan based on the current price and LTV. Second, a falling trend in gold prices may prompt lenders to adopt a more cautious approach and cap LTV at lower levels,” said Gupta.
So, if you have availed of a gold loan or planning to take one, do keep an eye on the prices of gold.