Surging gold loan business sets off RBI alarm

Several practices in gold lending pointed by supervisor; 3 months’ time to mend ways

– Team Finserv (finserv@vinodkothari.com)

The Reserve Bank of India (‘RBI’) issued a notification dated September 30, 2024^[1] raising concerns on the irregular practices observed in the grant of loans against pledge of gold ornaments and jewellery.

The RBI’s comprehensive review has unveiled notable deficiencies, including lapses in due diligence process, credit appraisals, ineffective monitoring of loan-to-value (LTV) ratios, a lack of transparency in the auctioning of jewellery upon default and so on. This notification compels all commercial banks, primary co-operative banks, and non-banking financial companies to undertake a meticulous evaluation of their existing gold lending processes and rectify identified gaps or shortcomings.

Accompanying the notification is an Annex (also tabulated below) that elaborates on specific irregularities, underscoring the necessity for enhanced governance and compliance with regulatory mandates. Entities are expected to implement corrective measures and report their actions within a three-month timeframe, with non-compliance potentially invoking severe supervisory repercussions.

Applicability:

All RBI Regulated Entities (REs) that extend gold loans/ loans against gold jewellery.

Effective date:

Immediately applicable.

Steps/action taken to ensure necessary implementation must be informed to the Senior Supervisory Manager (SSM) of RBI within 3 months i.e. by December 30, 2024.

List of Actionable:

Deficiency Identified	Rectification/Corrective Measures
In loans granted through partnership with Fintech entities/ business correspondents (BC), practices such as valuation of gold being carried out in the absence of customer, credit appraisal and valuation done by the BC itself, gold stored in the custody of BC, delayed and insecure mode of transportation of gold to the branch, KYC compliance being done through Fintechs, use of internal accounts for disbursement as well as repayment of loans were observed.	Redefining arrangement with BC/fintech entities/LSPsEnsuring that credit appraisal and valuation is not being outsourced and is done by the lender. However, in our view, appointment of a third party expert such as gold appraisers should not be considered as outsourcing. The intent is to ensure that core decision-making functions are not outsourced.Storage of gold to be done by the lender; safety vaults to be placed at the branches of the lender. The same is an existing requirement under the SBR Directions (para 37.5). Though the requirement is to have safety vaults specifically in the branches of the lender; however, for practical purposes the gold ornaments may not be kept there throughout the loan term. Hence, the lender may choose to transfer to a centralised vault subject to ensuring proper safety and security measures. KYC compliance cannot be outsourced- this was specifically restricted in case of banks (through a communication from RBI to IBA). It seems that this restriction will now extend to other REs as well irrespective of the provisions on KYC Directions allowing the reliance on CDD done by a third party (para 14 of the KYC Directions^[2]). This, in our view, does not restrict the BC from collecting KYC documents from customers and sharing the same with the lender to undertake appropriate CDD.Disbursement and repayment to be done directly between the RE and customer, without any routing through the BC/fintech. At the same time, the bank a/c of the intermediary cannot be used as a virtual lender’s account. This is similar to the restriction imposed by the DL Guidelines restricting flow of funds through any third-party or pass through account. Valuation of gold to be done in the presence of customer(s).Transit of gold to the branch should not be delayed and be done through secured means. This would imply that the transfer duration may be pre-decided (say, within a reasonable period- on the same day or within 1-2 days) and it must be ensured in practice as well.
Lack of a robust system for periodical LTV monitoring with instances of breach of regulatory LTV ceilings observed in some SEs. System generated alerts, where available, were not pursued actively to address the breach in LTV ceiling.	In the case of banks, the requirement to maintain LTV is specifically throughout the loan tenure. Further, the LTV is computed against the total loan outstanding in the account, including accrued interest, taking into account the current value of gold jewellery accepted as security/ collateral. However, in case of NBFCs, the LTV is computed and ensured only at the time of sanction, based on the value of loan sanctioned (principal amount). The general perception, due to lack of specificity, has been that in case of NBFCs, the LTV is to be seen at the time of granting of the loan only. The exact language of the regulation in case of NBFCs is “37.1.1 All NBFCs shall (i) maintain a Loan-to-Value (LTV) Ratio* not exceeding 75 percent for loans granted against the collateral of gold jewellery^{^[3]};” whereas that in case of banks is “ 2.3.11 a) Loan to Value Ratio* Loans (including bullet repayment loans) sanctioned by banks against pledge of gold ornaments and jewellery for non-agricultural purposes should not exceed 75 per cent of the value of gold ornaments and jewellery. Further, LTV of 75 per cent shall be maintained throughout the tenure of the loan for all loansextended against pledge of gold ornaments and jewellery for non-agricultural end uses.^{^[4]}” Does “maintaining” of LTV mean maintaining it all through the loan term? That seems quite logical. If LTV is the basic prudential safeguard, there is very little prudence in ensuring it at the time of lending but not thereafter. Note that gold prices do not appreciate as much as interest rates of the loan, and therefore, if the gold loan carries a compound interest, the LTV is bound to increase over time, especially in case of bullet repayment loans. If the RBI’s intent is to ensure that LTV is maintained at all times, one of the biggest selling points of NBFCs over banks will be lost.
Application of risk weights were at variance with the prudential regulations.	For NBFCs, gold loans fall under the category ‘other secured loans and advances considered good’ attracting a RW of 100. Even where the end-use is for personal consumption, gold loans do not attract a higher RW of 125% and the RW of 100% will apply^[5]. For banks, pledge of “eligible collateral” is one of the permissible modes of credit risk mitigation (para 5.12.3 read with 7.3.5 of the Basel III Regulations)^[6]. After giving appropriate haircuts, the value of gold may be deducted from the loan, and risk weight may be assigned to the net amount. Quite likely, this may result into zero or very low risk weighted exposure. It appears that the supervisor’s observations may have been in the case of NBFCs.
End use of funds was usually not verified for non-agriculture loans. Lack of proof or proper documentation obtained and retained in respect of agriculture gold loans.	In case of banks, gold loans extended for non-agricultural end use are subject to an LTV of 75% as per para 2.3.11 of the RBI Master Circular – Loans and Advances – Statutory and Other Restrictions^[7]. For NBFC, end use of funds is usually personal use which is not verified/ verifiable. It is quite common that the loan against gold jewellery is supported by an agricultural land based on a declaration by the borrower that the land is to be used for farming/agriculture. This is usually done to enable tagging the loan as PSL, even where there may not be sufficient proof that the loan proceeds would, in fact, be used for agricultural purposes. However, labelling the end-use of the loan as an agricultural loan and thereby classifying the same as PSL, should be based on: the extent of tilling/farming done by the borrower, whether on the self-owned or other land; the extent of farming needs, for equipment or sowing, etc. , including the seasonality; whether in view of the totality of the situation, is it likely that the borrower is using the gold loan for agricultural purposes? In case of non-agricultural loans, while the borrower does provide particulars of end-use, the same is not critical. Therefore, it is difficult to understand the supervisor’s concern on the non-monitoring of the end-use.
Lack of a specific identifier for top up gold loans in the Core Banking System / Loan Processing System with the SEs mostly to facilitate evergreening of loans. Also, no fresh appraisal was done at the time of sanctioning these top up loans.	At times, top up loans are given as a way to make good the delinquencies in the running loan. Ideally, a top up loan by its very nature is attached to the main loan, and should, therefore, be identified with the main loan or existing facility, such that any delays or defaults in the main loan are easily seen. Grant of a top up loan, while there are delays on the main loan anyways seems unreasonable. Further, top up loans should be sanctioned only after fresh appraisal is done for the borrower.
Many loan accounts were closed within a short time from sanction, i.e. within a few days raising doubts over the economic rationale for such action.	Where the closing of a loan account within a short time from sanction, raises doubts over the economic rationale for such action, then REs may evaluate it against the definition of a “suspicious transaction” under the KYC Master Directions, and file an STR (if appropriate).
Average realisation from auction of gold on default by the customer was low in certain SEs than the estimated value of gold, reflecting among other things, gaps in valuation process.	Lenders need to be very fair in the auctioning process, as sale of pledged jewellery at below-market prices is quite unfair, given the huge attachment that Indians have to their possessions. Losing it to the fall of misfortune, and still not getting good value, adds to the pain.
Share of gold loans disbursed in cash to total gold loans disbursed was high in some entities and the statutory limit specified under the Income Tax Act, 1961 on cash mode of disbursal was not adhered to in many cases.	Section 269SS of the Income Tax Act, 1961 deals with the provisions relating to mode of acceptance of loans. It states that no person shall take or accept from any person any loan or deposit otherwise than by an account payee cheque or account payee bank draft or use of electronic clearing system through a bank account, if any of the following amount exceeds Rs 20,000. Further, RBI requires lenders to ensure compliance with section 269SS and 269ST. Hence, cash disbursal of loans more than Rs.20,000 should not be undertaken.
Weak governance and transaction monitoring as instances of unusually high number of gold loans being granted to the same individual with the same PAN during a financial year.	To monitor the loans taken under a single PAN by the same individual, there must be methods for enquiries and verification- matching the loans taken in the past with the income/asset profile of the individual. In this regard, lenders may also consider incorporating corrective measures into the board-approved policy for verification of ownership of Gold. (W.r.t Para 37.2 of the SBR).
Practice of rolling over loans at the end of tenor, with only part payment.	Concerns of evergreening seem to have been noted by the supervisor. Lenders must take steps to restrict such practices of loan renewal by accepting part payment.
Non-categorisation of gold loans as NPA in the system, evergreening by renewing overdue loans/issuing a fresh loan, inadequate monitoring by Senior Management/ Board and inadequate or absence of controls over third-party entities.	This observation has several points bundled into one. The concern may not just be specific to gold loans per se but may be prevalent in other loan products as well. It seems to be miscellaneous observations. Each of these are points of concern and need to be attended to.