Lenders see opportunities in golden niche

My business has been slack for three, four months and I wanted a quick loan to fund my working capital," he said in Andheri, where he agreed to an interest rate of 24 percent for the jewellery, an amount typical for specialist gold lenders.
India's formal gold loan market is growing at 30 to 40 percent annually and attracting global interest. Abu Dhabi Investment Authority and a Goldman Sachs fund are among investors in Muthoot Finance, India's largest specialist gold lender, which starts trading on Friday after a popular $200 million IPO.
The opportunity is clear: Indians have traditionally used gold as a store of wealth and hold 10 percent of the global supply, much of it in jewellery. At the same time, more than half of Indian adults operate outside of the formal financial sector, according to the Reserve Bank of India.
The risk for the industry is that high interest rates and margins and the potential excesses of accelerating competition will draw a regulatory backlash of the sort that has crippled India's once-soaring microfinance sector.
Although gold is currently trading at more than $1,500 an ounce and hit a record $1,575.79 on Monday, a plunge in gold prices would erode the value of collateral held by lenders and undermine demand as borrowers receive less cash.
The short loan tenors involved in gold loans mitigate risk. The longer the term, the lower the loan-to-value ratio, which is typically 75 percent for three months.
"You're just taking a call on three months. It's not like you're doing a home loan for 20 years and you've got to live with the property," said Amit Saxena, chief executive of Karvy Finance, a unit of one of India's biggest brokerages, which entered the gold loan business last year.
Gold loans are safe if branches are secure and the lender properly appraises the collateral, which can be liquidated in case of default. Sentimental value means default rates are low.
Non-performing assets accounted for less than half a percent of Muthoot's retail loan book in recent years. Its gold loans stood at $2.9 billion at the end of November, about six times their total in March 2008, a listing document showed.
Others ramping up gold lending include Reliance Capital, controlled by billionaire Anil Ambani, and M&M Financial Services, part of the group that controls top utility vehicle maker Mahindra & Mahindra.
They compete in a fragmented industry with the likes of specialists Muthoot Finance and No.2 player Manappuram General Finance and Leasing, banks such as South Indian Bank Ltd, and unregulated moneylenders that charge more.
Organised firms control only one-quarter of an Indian gold loan market worth $50-$60 billion, according to Ambit Capital.

CAUTIONARY TALES
While the gold loan market is taking off, India has seen its share of busted finance booms. Most recently, the country's once-soaring microfinance sector was brought to its knees in late 2010 by regulatory agencies in the southern state of Andhra Pradesh, the industry hub.
Authorities were cracking down on high rates, aggressive recovery practices and overextended borrowers.
"The biggest risk to the sector is negative regulation," said Mahrukh Adajania, an analyst with Standard Chartered Bank.
"The spreads, or the margins, of gold players and of many other NBFCs (non-banking financial companies) are very high, and whenever margins in any one financial segment are very high it has caught regulatory and political attention," she said.
Organised players note they are already regulated by the Reserve Bank of India (RBI).
"In our industry we don't require any kind of force for collection...and this makes us less vulnerable to political pressure or more regulations," said Thomas George Muthoot, chairman of Muthoot Pappachan Group, which owns Muthoot Fincorp, a gold lender with more than 1,200 branches and which competes with Muthoot Finance.
The two firms are controlled by different branches of the same family in the southern state of Kerala. Muthoot Pappachan plans to raise about 8 billion rupees in an IPO by 2013 to fund expansion as it targets loan growth of 85 percent a year.
Already, the sector has been squeezed by regulation.
In February, the RBI removed gold lending's "priority sector" status under which banks could meet regulatory requirements by buying gold loan portfolios, which provided a ready and relatively cheap source of funding for gold lenders.
Other regulatory risks include a possible cap on interest rates or rules imposed by individual states, Ambit Capital said.
"These kinds of regulatory negative surprises could happen from time to time...like what happened with the microfinance industry," said J. Venkatesan, a fund manager at Sundaram Asset Management, which held Manappuram shares at the end of March.

INTENSE COMPETITION
With competition intensifying, some players worry that the tactics and unsavoury practices of some newcomers might show the industry in a negative light.
"They are very aggressive in opening more and more branches, but if they don't have an effective risk management mechanism within, then it is a problem for them, which will be bad for the industry," said V.P. Nandakumar, chairman of Manappuram.
Growth of organised operators could, however, raise standards in a sector still dominated by unregulated players.
Some analysts say pure-play operators are best poised to compete given their extensive branch networks, established reputations, risk management expertise -- including appraisal and security -- and the ability to grow quickly.
Banks enjoy customer trust, but have higher cost structures and regulatory limits on expansion. Muthoot Finance, by comparison, was able to add more than 1,000 branches in less than a year, to 2,611 at the end of February.
"Our assessment is that it is not very easy to replicate operations overnight," said Ambit analyst Krishnan A.S.V.