In my previous post on asset allocation and investing post-Covid, I had briefly explored Gold from a direct investing point of view and had concluded that it did not make sense to me.
Gold: Gold has no utility for me. If the Dollar really fails, I don’t see people transacting in physical gold. It earns no income. It’s difficult and expensive to store. Jewellery is okay but as an investment at the portfolio level, I don’t understand it. Prices are currently at highs, but I guess valuations matter less for gold. The current crisis has shown that gold can be unreliable, and people queue up to sell when everything else is falling. I assume a large allocation in gold can only be done through a financial instrument – in other words buying paper gold. Doesn’t this defeat the purpose of gold as a safe haven?
Nevertheless my interest in exploring Gold lingered from a portfolio diversification point of view and because of the massive increase in money supply globally. Happily, last month I chanced upon Digant Haria’s brilliant presentation on Indian lenders where I learnt about Gold financiers. The whole presentation is worth your time for a masterclass on lending, but for now I want to focus on Gold lending which may just be my new favourite business model.
Gold Demand in India
India’s love affair with Gold is well known, and Gold is a vital part of Indian cultural identity, financial security and social status. India represents approximately 25% of global gold demand every year and nearly two-thirds of this demand comes from the “Real India” – our rural communities. While asset allocation in Gold is relatively high across India, in states like Andhra Pradesh, Goa, Telangana and Kerala this number reaches over 20% and is the bedrock of household savings. Naturally then Indians have been monetising Gold holdings for centuries by pledging their Gold ornaments to lenders who provide short term loans against this collateral. This has created a highly unique, durable and rapidly formalising (35 percent organised) Gold loan industry. In many cases Gold loans have represented the average Indian’s first contact with the formal financial system and organised Gold lenders have saved millions from exploitation at the hands of money lenders and pawn brokers while also helping them build credit records.
Taking a Gold Loan
Let’s take a quick look at how Gold loans work. If you need immediate cash and have some Gold to pledge, where do you go? You have 3 options:
a) a specialised Gold loan NBFC,
b) a bank, and
c) a money lender.
Comparison of Gold loan offerings
|Parameters||Gold NBFCs||Banks||Money Lenders|
|LTV||Up to 75%||Up to 75%||>75%|
|Processing fees||No||For large loans||No|
|Interest rate||11% – 24%||7% – 15%||25% – 50%|
|Loan amount||No limit||No limit||No limit|
|Working hours||Beyond banking||10 – 5||Beyond banking|
|TAT||5 – 10 min||> 1 hour||> 10 min|
|Repayment||Monthly interest payment with principal at end of tenure||Interest + principal as lump sum at end of tenure||Daily or monthly repayment|
As you can see, Gold loans, especially from specialised NBFCs, are extremely compelling products for low, middle and upper middle income households (97% of India!). They involve minimal paperwork, easy KYC checks, carry reasonable interest rates, and have extremely quick turnaround times.
The Beauty of Gold Financing
Apart from the attractive product attributes from a borrower’s perspective, there are 5 key reasons why I think gold financing is an amazing business with deep competitive moats for incumbent lenders.
- Operationally challenging – Gold lending is an extremely operations heavy business and not something that can be run by your average banker sitting in Fort. You need to set up branches close to your customers, often in far flung rural areas. When a customer comes through the door, you need people to appraise the gold correctly and make the loan decision and disbursal in less than 10 minutes. Gold and cash need to be securely stored locally in vaults with water-tight security (how will you explain to the customer that you lost his wife’s wedding set?). If the customer defaults on their loan, you need a team to auction the gold as per regulatory requirements. You get the idea. Operational excellence in gold lending is a huge moat. Muthoot Finance, the leading gold lender in India, runs operating costs at 4% of AUM with the next best player (Manappuram) at 7% of AUM.
- Trust – Gold loans require extremely strong consumer brand recall unlike other types of loans. Do you really care where you get a home loan or vehicle loan from? Does it really matter whether it came from HDFC, Kotak, or Indiabulls? Nope, only the interest rate matters. If one of these lenders goes bust, you don’t care as a borrower and might even hope that your loan might be forgiven. For a Gold loan on the other hand, you have taken your personal family jewellery and deposited it in the branch of the lender and got only 70% of its value in cash. You absolutely care about getting this jewellery back and whether there is any risk of your lender going bust. Building this trust is super hard. This is precisely what the Muthoot Group has managed to do after being in the business for over 130 years (founded in 1887). Similarly, Manappuram Finance has been doing this for over 70 years.
- Collateral – Gold loans provide lenders with collateral that is real, super liquid, holds value superbly, and is extremely valuable to the borrower. The customer begs, borrows, steals his wife’s/mom’s Gold ornaments to pledge in return for cash. Losing this collateral not only entails a monetary loss but a huge reputational and social loss as well. Theoretically even if the value of the Gold falls by 50%, the customer will not default on the loan! As a result, Gold loan NBFCs have never had to worry about NPAs, the bane of all other lenders. Fun fact: Muthoot Finance privately holds 176 tons of Gold as security as of March 2020. This is equal to 27% of the total sovereign Gold reserves held by RBI and 60% of the reserves held by RBI in India (the balance is held overseas)!
- Inbuilt risk management: This is perhaps my favourite quality of Gold lenders especially in the Indian context – it is impossible to go out and distribute loans recklessly. A customer has to come to your branch, pledge his Gold and then you’ve made a loan. Your ability to lend depends on the quantity of Gold available with customers and your ability to convince them to part with it. Banks and NBFCs in India have distributed money recklessly over the years to maintain 25%+ AUM growth and sky high valuations. In the last two years they have all faced huge NPA issues which they conveniently blamed on IL&FS, DHFL, Demonetisation, Covid-19 etc. The next few quarters will be extremely testing for lenders as moratoriums expire. Gold loan growth is slow but solid! There are no excesses in this business.
- Stronger amidst Covid-19: Gold prices have been on a tear this year providing strong buffers to asset quality for Gold lenders. High Gold prices are also incentivising customers to monetise their Gold driving AUM growth in an environment where every other lender is racing to run down their lending books as liquidity has dried up. Further, even though customers may have to delay repayments by a few months, actual loss given defaults will be extremely low for the reasons discussed above. The organised Gold lenders which kept pace with technology already offer ‘Online Gold Lending’ which allows you to store your Gold safely in their lockers (taking care of the storage problem of physical Gold) and monetise at any time with a click. The market has begun to recognise this and rewarded Gold lenders handsomely. Muthoot Finance is currently trading at an all time high and has outperformed the NIFTY and other blue-chip lenders by 50 – 70 percentage points YTD!
In conclusion, Gold loans are a truly unique and robust “Made for India” financial product that are having their moment in the sun in these strange times, and are well worth investor (and borrower) consideration.
Disclosure: I am invested in Muthoot Finance. This is not an investment recommendation. Please do your own research.