Gold Price Fall

What are the problems gold loan companies would face under tension if the bulk of their funding is securitized receivables?

Gold Price FallRemember, it’s the mortgage-backed securities, which supported the housing bubble in the US. Savvy home loans were securitized, tied up, and accorded higher rating which investment banks sold to “smart” hedge funds while “smart” insurance companies like AIG insured them.

Underlying this chain of transactions was a key assumption. House prices in the US never decreased all across the country for a long period. It is the same assumption for Gold Loan receivables too – gold prices never fall in India.

In the US, when house prices fell everywhere in 2007 and 2008, the securitized loans and the insurance written on it (credit default swaps) started to blow up. Massive losses, bankruptcy, and financial panic followed in quick succession.

There is no question of that kind of panic here because the gold loan market is too small and localized. But to assume gold prices do not crash or that it will leave no impact are both dangerous.

A sharp gold price fall is likely to set off a chain of events that may wreak havoc on the financial structure of gold loan companies. If gold price fall by 30%-40%, the loan provider would either need the borrower to put up more gold or make good the margin in cash.

What if the customer is unable to meet the shortfall and starts defaulting on her loan?

The company will be forced to auction-off the pledged jewelry at a much lower price in the market. Selling used household jewelry in a falling market will invariably lead to a still lower realization.

What will creditors (the banks) to gold loan companies do in such a situation?

They will be left holding receivables from housewives which would have declined in value and which they would find it impossible to liquidate. A small panic would ensue.

Family jewelry carries a lot of sentimental attachment. When the men take the loan, there is  pressure from the women to redeem the gold as soon as possible. Most of these borrowers choose to prepay the loans and the chances of default are very unlikely.

In India, gold is not a commodity for the common man; it is ‘Lakshmi’ (the Hindu goddess of wealth). They would think of losing that jewelry only if they are in severe difficulty. So this question of risk in terms of imbalances may not arise.

Gold Loan Providers :

  1. Allahabad Bank
  2. Development Credit Bank
  3. Muthoot Finance
  4. Andhra Bank
  5. Federal Bank
  6. Oriental Bank of Commerce
  7. Axis Bank

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