Why RBI's flip-flop in gold loan regulation is sending confusing signals

What does the Reserve Bank of India (RBI) want to do with the gold lying at Indian households? This is a question that begs an answer from the central bank, given its flip-flops on norms that govern the gold loan market.

On Tuesday, the central bank lifted a ceiling of Rs 1 lakh it had set for loans given by banks against pledged gold, where the repayment is done at the end of maturity. The restriction was imposed by the apex bank only seven months back to “ensure a level playing field among various market participants”.

There are two interesting aspects to the development: For one, there was never such a ceiling applicable on the quantum of loans that gold loan NBFCs, which control half of the market, can give to customers against the pledged gold; secondly, according to bankers, even commercial banks have been giving loans much above Rs 1 lakh all this while, even when the said limit was supposedly in place.

That means, for all practical reasons, no one seemed to know or they didn’t take the rule very seriously even when it existed. Bankers, for that matter even the RBI, do not seem to be convinced about the central bank’s rationale of setting a limit on the quantum of loans that can be borrowed against gold.

“My guess is that the RBI wanted to have a check on the creation/circulation of money due to inflationary pressure,” said a senior banker replying to the question on the possible intent behind the central bank’s action. Does the RBI want to control inflation by dictating to the citizens on what they should do with their gold savings?

Major players in India’s gold loan market are non-banking finance companies (NBFCs) such as Muthoot Finance and Manappuram Finance, which control half of the organised market. The remaining share is with commercial banks.

There are a few questions the central bank could try answering here:

One, the RBI has been acting rigorously to streamline gold loan market in the recent past. In 2013, the central bank capped the loan-to-value (LTV) ratio for gold loans at 60% of the value of the pledged gold and later raised it to 75% in early 2014 for both banks and NBFCs.

Besides this, to discourage Indians from investing in gold, both the government and RBI have been talking about promotion of alternative investment products such as gold exchange traded funds, gold accumulation plans, gold-linked accounts, modified gold deposits and gold pension products, among other measures. Where do all those reform plans stand?

Neither the RBI, nor the government is talking about gold-backed investments because the current account deficit (CAD), the core reason that prompted the reform process towards the fag end of the UPA’s tenure at the Centre, has come under control following significant decline in gold imports. Hence reform talks have conveniently taken a back seat and wouldn’t come forth until deficit figures widen again.

Even then, it will be difficult to cure the gold fever in India because Indians do not consider gold as a mere commodity to grow their money but part of their traditions and customs .

If the larger idea is to encourage the use of domestic gold stocks, in the first place, keeping a ceiling on the amount of loans that can be borrowed against gold didn’t make any serious sense, whether the repayment is done through a bullet mode or not. Instead, from the very beginning, the RBI should have encouraged gold loans through formal channels. Remember, the formal market is only one-third of the informal gold loan market.

If risk emerging out of such loans is a concern, wouldn’t the LTV cap of 75 percent be sufficient enough to take care of it? The answer is yes, because this restriction can ensure that default risks on such loans do not reach dangerous proportions. As long as gold is with the lender as underlying asset, the loan carries zero risk.

Second, the RBI regulates both banks and NBFCs. Given that the market for gold loans are equally shared by both banks and non-banks, why two types of rules for those who do the same business?

Given that there was no restriction on the quantum of money NBFCs can lend against gold, one could have easily gone to a nearest Muthoot or Manappuram branch and get the deal done, even if he doesn’t get loan beyond Rs 1 lakh from a bank branch.

Bottom line: the RBI has done well by correcting its mistake (lifting the loan ceiling). But the central bank must be clear on regulations pertaining to the gold loan market, to avoid confusing signals to markets.

More importantly, the same regulations should apply to everyone if the business is of the same type.If not, the regulator could very well find itself in an awkward position.