Gold Finance Companies and Their Revenue Models-II
Borrowing for gold is becoming more and more popular as the price of the yellow metal hits the stratosphere and Indians lose their inhibitions about pledging their family heirlooms as collateral. Is it safe to do business with these gold lending companies?
In the previous part of this two-part series, we looked at how gold loans have grown in popularity (http://www.moneylife.in/article/78/9891.html). We now take a look at the revenue models of these gold lending companies.
The main advantages for a gold lending company are as follows:
1) The large interest they can charge on these loans. The illiterate farmer has nowhere else to go and this was an opportunity for these businesses.
2) They operate with huge margins – sometimes up to 20%.
3) They offer very short loan terms and they can ask the borrower to repay / donate more assets or auction the securities (and in the auction too there is so much fraudulent activity like not giving the borrower notice / imposing very high penalty rates / taking the ornaments promised at auction through people they know the list goes on).
4) No elaborate documentation involved. Just a promissory note and an application form.
5) Safely keeping documents / securities was easier (as they were just wrapped in a cloth bag and kept with the borrower’s name in their vault. And today a brokerage firm has to keep its actions and its clients. actions separately – these gold lending companies do not have such standards).
6) Normally there are huge increases in the market rates of the pledged assets resulting in a big payoff for the lenders due to the high margins when granting a loan.
7) These companies have adopted complex networks for easy access, appearing as a “savior” to the local population.
While banks have prospered well and have been successful in the banking sector by initiating other loans like cash loans, term loans by lending to industrial and commercial activities, small NBFCs (non-bank financial corporations) and corporations gold financing could not do it in organized sectors. They continued to lend for adornments to their existing clientele and survived. When the liberalization process began in India, these companies could see a silver lining for survival and patiently waited for banks to diversify. Along with the banking reforms implemented thanks to the intervention of the Reserve Bank of India (RBI), these companies offering loans against gold have started an active campaign for their return not to traditional growth areas, but for the same old “Loan against gold ornaments category.” These companies limited their operations to local districts (or at most their states) to float in the turbulent market, so they would be well positioned to reap the benefits of a possible recovery of the market.
And now we’re seeing some of the companies trying to reach a Pan-Indian audience, with branches in key centers. It can be seen that all these centers will be areas dominated by the middle and lower classes. They offer massive advertisements to attract customers. These companies try to raise funds from the public both through debt and equity.
Some of them want to launch Initial Public Offerings (IPOs) to reach current market highs and some are raising funds through private placements.
Even compared to industries like real estate, these gold lending companies find it easier to attract entities for equity investment or equity loans.
Ultimately, these lenders are looking for short term returns and are not long term players in this market. Gold lending companies are confident that none of their FDs or obligations will be rated. And it’s the same with their deposits. Therefore, they take deposits from the public in the same way they collected before. As the cost of deposits has fallen over a 20-year period today, they are able to take deposits at 15% per year (up from 24% previously) and lend between 24% and 30% per year. These costs may not be transparent as they will have expert fees, quarterly / semi-annual processing fees, on-call fees, etc.
These sums are taken for a period of 1 to 5 years and they also borrow from private usurers and certain banks against securities. Pooled money is loaned against ornaments at exorbitant rates where they have at least 10% gross margin. Their operating cost is very low as they operate from ordinary locations; thus saving on overheads and personnel cost is not at market level. The people employed are not qualified professionals. Thus, they are able to achieve a huge profit margin and have started to approach the population of the urban / metro area, using the latter’s greed for business assets and high-end lifestyle.
Is it safe to deposit money with these companies?
No, for the following reasons:
1) They have no regulator. Although they say they are regulated by the RBI, the RBI’s hold over these companies is too weak. They report to the NBFC; depositors should not forget the hard times they went through when the NBFCs offered very high interest rates and incentives to mop up deposits and suddenly the bubble burst. Anyone paying more than 200bps (around 10% now) should be avoided.
2) These companies do not have any back-to-back assets. They do not have fixed assets to floating assets like commodities and work in progress. They only have the money collected from you and other sources, and at any point in the fall there is no basic asset depreciation for them.
3) They do not have a long term plan to diversify into other areas of business and unless there is diversification into related areas in a financial services company, growth cannot continue. produce. Therefore, they are nearsighted and want to enjoy the sun now.
4) Their economic model depends on only one metal and the vagaries of the price of this single asset, gold, will affect them both ways to a greater extent.
5) The deposit guarantee schemes granted by the government will not apply to deposits made with these gold lending companies.
6) Due to cost constraints, they operate from tiny residential areas; monitoring them will be difficult.
7) There is no transparency in their deployment of the funds raised because many are not listed companies or come under the jurisdiction of a regulator such as SEBI or IRDA.
And what about using them to raise loans?
Invariably, you will be asked to deposit money or pay an interest rate based on the amount financed. The usual margin they have is 25 to 40%. And the amount you will have on hand plus the interest you will be paying will be a huge burden on you. Since these are considered short term loans, you have to close them on time or pay through the nose again to have them roll over. EMIs are structured in such a way that the bulk of it goes to the interest of the initial period (although these are short-term loans). As a result, you will be able to lose the ornament and the replacement cost will be higher for you with the cost of the yellow metal increasing.
Therefore, investors are urged to exercise the utmost caution when dealing with these companies. It is time for them to be properly controlled by the regulator and for their transactions to be made more transparent.
(The author is a management and financial consultant and can be contacted at [email protected])