Gold Loan Interest Rates are Not High

A housing loan is available at interest rates of between 10 to 12 percent but interest rates charged by NBFCs on gold loans can go up to 24 percent and more. Consequently, gold loan NBFCs occasionally face criticism that they charge high rates are high, particularly because their customers belong mostly to the economically weaker sections. However, a deeper analysis reveals that this is not true, particularly when one considers the overall cost-benefit equation from the point of view of the gold loan borrower.
A product or service can only be offered at a price that covers the cost of production plus a reasonable profit margin.  Without recovering the cost and generating reasonable returns for the producer, the activity is not worthwhile and the business cannot be sustained. Unlike banks that have access to low cost deposits from the public, especially savings and current accounts, the cost of funds for NBFCs is much higher, about 12 to 13 percent. This automatically pushes up the minimum rates at which they can lend.
Gold loans are small ticket, short duration loans that are typically repaid within three to four months. In contrast a housing loan is taken for 15 to 20 years and for large amounts, typically, Rs.10 lakhs and more. In a housing loan, once the disbursement takes place, there is very little administrative cost involved for the financing institution other than keeping track of periodic repayments.
Because a GL is repaid within 3 to 4 months, there is constant churn in the portfolio. Even to maintain the gold loan portfolio at a certain level, fresh loans have to be constantly given out. Consequently, administrative costs are much higher. As a rule, the cost involved in handling small ticket loans is higher than in big ticket loans (because economies of scale are present) and the only way to recover the higher cost is by levying higher interest rates.
For instance, in a bank, a small team of two or three officers can disburse a housing loan of Rs.30 lakhs at an interest rate of 10% which earns the bank about Rs.3 lakhs in the first year. In contrast, to attain the same level of business in gold loans, requires disbursement of 900 gold loans (at an average ticket size of Rs.30,000 and average tenure of four months).  Clearly, the gold loan business cannot be carried out at the same interest rates as in the housing loan sector.
Further, experience tells us that when it comes to small ticket/ short duration loans, the rate of interest expressed as an annualised percentage does not matter. What matters is the actual amount of interest paid out in relation to the borrower’s cash flow. Example, a loan taken at an interest rate of 30% p.a. appears usurious but if the loan amount is small, say Rs.10,000, to be repaid in three months, the total interest works out to Rs.750. In Kerala, this is less than two days wages for a labourer. Borrowers also consider the time saved and the hassle free experience in availing a gold loan from an NBFC like Manappuram as an opportunity cost saved which makes the deal worthwhile despite the higher interest amount paid.
Like all customers, Gold loan borrowers consider not just the price, but also the value in the product (i.e. the price to value equation). It’s well known that NBFCs disburse a gold loan in a matter of minutes. A “cheaper” gold loan from a commercial bank would involve multiple visits to the bank and sacrifice of a day’s (or two day’s) earnings. When you factor in the “opportunity costs”, NBFCs are much cheaper. Customers don’t have to sacrifice the earnings for the days spent following up at the bank or fulfilling cumbersome procedural requirements.
That is why, even where a nationalised bank’s branches are located right next to our branches, we end up doing much more gold loan business than they do. It proves that for the actual gold loan consumers, the annualised rate of interest alone is not the main consideration.
At the same time, the gold loan business has considerable risks in it which form part of the cost and that cannot be ignored and. For example,

•    A product or service can only be offered at a price that covers the cost of production plus a reasonable profit margin.  Without recovering the cost and generating reasonable returns for the producer, the activity is not worthwhile and the business cannot be sustained.
•    Unlike banks that have access to low cost deposits from the public, especially savings and current accounts, the cost of funds for NBFCs is much higher, about 12 to 13%. This automatically pushes up the minimum rates at which they can lend.
•    Gold loans are small ticket, short duration loans that are typically repaid within three to four months. In contrast a housing loan is taken for 15 to 20 years and for large amounts, typically, Rs.10 lakhs and more. In a housing loan, once the disbursement takes place, there is very little administrative cost involved for the financing institution other than keeping track of periodic repayments.
•    Because a GL is repaid within 3 to 4 months, there is constant churn in the portfolio. Even to maintain the gold loan portfolio at a certain level, fresh loans have to be constantly given out. Consequently, administrative costs are much higher. As a rule, the cost involved in handling small ticket loans is higher than in big ticket loans (because economies of scale are present) and the only way to recover the higher cost is by levying higher interest rates.
•    E.g. In a bank, a small team of two or three officers can disburse a housing loan of Rs.30 lakhs at an interest rate of 10% which earns the bank about Rs.3 lakhs in the first year. In contrast, to attain the same level of business in gold loans, requires 900 gold loans to be disbursed (at an average ticket size of Rs.30,000 and average tenure of four months).  Clearly, the gold loan business cannot be carried out at same interest rate as in the housing loan sector.
•    Experience shows that when it comes to small ticket/ short duration loans, the rate of interest expressed as an annualised percentage does not matter. What matters is the actual amount of interest paid out in relation to the borrower’s cash flow. Example, a loan taken at an interest rate of 30% p.a. appears usurious but if the loan amount is small, say Rs.10,000, to be repaid in three months, the total interest works out to Rs.750. In Kerala, this is less than two days wages for a labourer.
•    Borrowers also consider the time saved and the hassle free experience in availing a gold loan from an NBFC like Manappuram as an opportunity cost saved which makes the deal worthwhile despite the higher interest amount paid.
•    Like all customers, Gold loan borrowers consider not just the price, but also the value in the product (i.e. the price to value equation). It’s well known that NBFCs disburse a gold s for the days spent following up at the bank or fulfilling cumbersome procedural requirements.
loan in a matter of minutes. A “cheaper” gold loan from a commercial bank would involve multiple visits to the bank and sacrifice of a day’s (or two day’s) earnings. When you factor in the “opportunity costs”, NBFCs are much cheaper. Customers don’t have to sacrifice the earnings for the days spent following up at the bank or fulfilling cumbersome procedural requirements.
•    That is why, even where a nationalised bank’s branches are located right next to our branches, we end up doing much more gold loan business than they do. It proves that for the actual gold loan consumers, the annualised rate of interest alone is not the main consideration.
•    At the same time, the gold loan business has considerable risks in it that cannot be ignored and which form part of the cost. For example, appraisal risks and custodial risks are critical risks in the business and measures to counter these are costly. Equally, the price risk (the loss is important and it’s only a coincidence that for the past few years, gold prices have been increasing. Should there be a reversal in the trend, it’s possible that the gold loan business may suffer losses too.
•    Finally, comparisons with the interest rates on gold loans given by commercial banks to agriculturists are not valid because these loans are eligible for special benefits from the government.

 
Mr. V.P. Nandakumar
MD & CEO,
Manappuram Finance Ltd.