Industry Analysis: Gold Finance

Summary

Gold Finance NBFCs are facing strong competition in the market but still their is a bright future ahead for NBFC's because of under-penetration in the field of gold financing and addition of new customer will keep their growth story intact.

Indian households hold a massive 14% share of global gold at 27,000 tonnes, with only 20% pledged. The unorganised sector controls 65% of the market, with organised players such as banks and NBFCs vying for the remaining 35%. In terms of value, India's share translates into Rs 130trn (Rs85trn Jewellery share), presenting a potential Rs 63trn market opportunity at 75% LTV; currently, the organised market operates at a mere Rs 6trn. Since the last 15 years, specialised gold finance NBFCs such as Muthoot Finance (MUTH) and Manappuram Finance (MGFL) have been the undisputed leaders in India's gold financing business. However, the two are now in the eye of a storm as banks/fintechs and other NBFCs such as IIFL Finance (IIFL) have become more aggressive in the space. What draws this diverse group of organised financial players into the arena is asset quality safety and the enormous untapped potential. Their sudden focus on gold financing may cause a short-term disruption in the market, particularly for the two specialised players. However, we expect the total pledge ratio to rise to 25% over the next five years, with the organised share rising to 45%, driving a 13% CAGR in the gold loan market.

India is the most important market for gold-loan financiers: India has one of the world's largest gold loan markets, with Indian households owning over 27,000 metric tonnes of gold (14 share). At current gold prices, this translates into a potential market opportunity of Rs 65 trillion, compared to the organised market's mere Rs 6 trillion. This bodes well for focused/large gold financiers such as MUTH, MGFL, and IIFL. While increased competition from banks/fintechs may continue to impact gold loan NBFC growth in the short term, we believe there is ample space and opportunity for all players, including banks, NBFCs, and fintechs, to co-exist and expand in the long term.

Market with huge potential: At only 7%, India's organised gold loan market is grossly underpenetrated. Given Indian households' large gold holdings, we see significant opportunity for organised gold-loan financiers, as even 1% additional penetration could drive 15% growth for the entire organised segment. Furthermore, with banks and NBFCs focusing more on gold loans, the shift to the organised segment may outpace previous trends. We anticipate that the organised segment will increase to 45% from 35% in the next five years, contributing an additional 5% CAGR to the growth of the organised gold loan industry. A combination of the two factors (at current gold prices) could propel the gold loan industry to a 13% CAGR over the next five years.

Long-term growth story unbroken: After nearly a year of intense price war, pricing sanity is returning, with most NBFC players discontinuing their teaser rate (10% yield) schemes. Despite the risk that NBFCs will lose more high-ticket customers to banks and fintechs, primarily due to interest differentials, we expect growth in new customer addition (small-ticket customers) to offset the losses caused by big-ticket customers in the long run, owing to the vast untapped market.

India has the world's largest gold stock, with over 27,000 metric tonnes of gold held by Indian households, accounting for 14% of the world's total gold stock. Over the last 10/20 years, the gold stock in Indian households increased at a CAGR of 3%/4%, while the global stock increased at a CAGR of 1.7%/1.7%. As a result, India's share of global gold stock holdings has risen from 8%/11% in 2000/2010 to 14% today. At the current price, this translates into Rs 130 trillion in gold holdings, 65% of which is in the form of jewellery. As a result, at 75% LTV, the potential market opportunity is Rs 63 trillion, compared to Rs 6 trillion in the organised market today. In 2010, only 3.5% of total household gold holdings in India were pledged with organised players (banks + NBFCs), which has more than doubled to 7% in FY22 (though still lower), representing a 10% CAGR. Because of the enormous gold holdings in its households, India is one of the world's largest gold loan markets, implying enormous potential for focused/large gold financiers such as MUTH, MGFL, and IIFL. While increased competition from banks/fintechs may continue to impact gold loan NBFC growth in the short term, we believe there is ample space and opportunity for all players, including banks, NBFCs, and fintechs, to co-exist and expand in the long term.

Rising Demand of Gold Loan:

The demand for gold loans has increased significantly over the last 8-10 years, owing to the lower interest rates charged by organised players (compared to moneylenders and pawn brokers), quick disbursement, flexible terms, and perceived safety of the ornaments. Furthermore, high rural indebtedness, ineligibility for bank loans, and customers' changing attitudes toward gold loans have all contributed to the sharp increase in gold loans. Given household gold holdings, India's gold loan market is grossly underpenetrated, with only 7% penetration. This provides organised gold-loan financiers with significant room for expansion. Every 1% increase in penetration could result in a 15% increase in growth for the entire organised segment. With banks and NBFCs increasingly focusing on gold loans, we believe the transition to the organised segment will be faster than in the past. We believe it will take only 5 years for the organised market share to increase by another 10%, as opposed to the 10 years it took to achieve the previous 10% gain. We expect the organised segment to grow from 35% to 45% in the next five years, supporting the industry's healthy growth.

Gold loan finance is an estimated Rs 6 trillion+ industry, with banks managing 80% and NBFCs managing 20%. While banks have a larger market share, agriculture (agri) gold loans account for 72% of their gold loan portfolio (i.e., 56% market share excluding agri gold loans), where yields are lower. Banks have historically been active in agri gold loans because they not only help them meet their priority sector targets, but they are also considered a safer way to meet these targets. However, agri gold loans typically have low returns and a high default rate. Even in the non-agri gold loan segment, the organised segment is their target clientele because they are unable to provide the same level of flexibility and rapid disbursement as organised NBFCs. Furthermore, banks and NBFCs have distinct dynamics: organised NBFCs prioritise customer convenience, quick disbursement, and flexibility, whereas banks prioritise lower interest rates and larger ticket sizes. Banks charge 7-15%, whereas NBFCs charge 11-22%. Despite the fact that banks offer lower interest rates, small-ticket customers prefer NBFCs because 1) the process at NBFCs is much faster than at banks. 2) NBFCs do not have a lock-in period, whereas most banks do.

NBFC market shares increased rapidly from 13% in FY08 to 28% in FY12, as they increased their focus on gold loans. However, their market share remained stable at 25-35% from FY13 to FY20, as banks continued to view it as a non-focus area. However, COVID-led economic distress since 2020 has created a captive market and sustained demand for gold loans to the point where large public sector banks such as SBI/BOB/Canara Bank have begun refocusing on the product and, in fact, have been aggressively expanding their gold loan books. The proportion of gold loans in bank portfolios has risen to 5%, up from 3.3% in FY20. As a result, NBFCs' market share has fallen from 23% to 20% in the last two years.

The gold loan market has turned into a battlefield in last two years, where players across the spectrum, be it banks, NBFCs or fintechs have turned aggressive and started undercutting each other on interest rates. As banks/ fintechs got aggressive into this space, NBFCs began offering teaser rates of 6-7%, denting their NIMs seriously. Sanity in terms of pricing is now getting restored, almost after a year of price war, as most NBFC players in the space have discontinued their teaser rate schemes. Nonetheless, we believe NBFCs run the risk of further losing high-ticket customers to banks and fintechs, due to the interest differential. However, we expect growth in new customer addition (small-ticket customers) to offset the loss of big-ticket customers in the long run. While the entry of banks in the gold loan segment is causing some high-value NBFC customers to shift to banks, at the same time, increased promotions by banks is attracting new customers to the formal sector. This could benefit all gold loan players, including NBFCs, in our view. We expect the migration of high-ticket customers to settle down in a quarter or two, post which gold finance NBFCs would see their normalised growth restore FY24 onwards. 

Until FY12, gold financing companies had a fantastic time; their balance sheets grew exponentially with little regulation from the RBI. However, a sharp drop in gold prices in 2012, combined with the introduction of stringent regulations by the RBI, had a significant impact on their borrowing costs and balance sheet growth. In 2011, the RBI denied banks priority sector status for loans made to gold-loan NBFCs, resulting in a 2% increase in borrowing costs for gold-finance NBFCs. 

Also in 2012, the RBI reduced banks' lending limit to a single NBFC in the gold-loan business from 10% to 7.5%. Another major setback occurred in March 2012, when the RBI set the maximum LTV at 60% (later increasing it to 75%). Lower LTVs, combined with lower gold prices, significantly eroded MUTH and MGFL portfolios, as customers turned to banks and the unorganised sector, where there were no LTV limits. During FY12-13, market shares of specialised gold-loan NBFCs fell by 5-8%. Due to a sharp decline in business, gold-loan NBFCs were forced to reconsider their strategies and rework their business plans. They clawed back around 2-3% market share by FY15, regaining some of the lost ground. Today, with a stable regulatory regime and domestic gold prices remaining stable, these NBFCs appear poised for long-term growth as the gold loan market expands.

Valuation:

While emerging trends in the gold loan NBFC business points to intensifying competition, likely translating into relatively lower return ratios and growth, we believe significant under penetration of the formal sector, and increased focus on low-ticket customers, will likely restore growth of gold-loan finance NBFCs towards normalised levels by FY24/25, though their RoE profiles are likely to stabile at 17- 20%. 

Source:

1.) Reserve Bank of India 

2.) IIFL

3.) Mannapuram Finance

4.) Muthoot Finance

5.) World Gold Council