The Reserve Bank of India (RBI) recently advised regulated entities (REs) in the financial sector to comprehensively review their policies, processes and practices on gold loans after its onsite examination brought to light irregular practices at some REs.

It may be recalled that in March the regulator had imposed restrictions on a non-banking financial company (NBFC) for deficiencies in the firm’s gold loan portfolio. While issues like variance in the application of risk weights when a gold loan becomes a non-performing asset (NPA), or non-categorisation of a gold loan as NPA in the system, or evergreening by renewing overdue loans or by issuing fresh loans can be addressed by finetuning the processes and audit trails, the others are serious in nature.

Here are some of the key areas of concern in the gold loan business and the measures needed to foolproof it.

Lending through outsourced entities, or third-parties, or business correspondents (BCs): The RBI has commented on the valuation, custody, delay and insecure mode of transportation of gold by outsourced entities, particularly BCs. Gold as a loan security is different from shares and mutual fund investments, which are demat securities. The weight and purity of a physical commodity like gold are at risk of manipulation before it reaches a banker for loan disbursal. A question arises whether this activity should be allowed to be outsourced. The loan applicant alone should bring the gold to the banking counter, and only the loan application, know-your-customer (KYC) verification, and vetting should be outsourced. Loan disbursal can then be quicker at the bank, which would only need to test the purity and weigh of the gold.

Valuation of gold in the absence of the customer: Two years ago, at a scheduled commercial bank (SCB) some gold loan customers had alleged that a part of their pledged gold ornaments was missing at the time of redemption. The modus operandi they alleged was as follows: In a separate cabin for gold loan applicants, the bank official collected the ornaments and the filled forms before asking the customer to go outside and fetch photocopies of KYC documents. On returning, the gold is weighed in the customer’s presence and the loan sanctioned. The suspicion was that the official had removed a small portion of the ornament, not immediately discernable to the customer’s eye. It remains unknown how the case was resolved, but the takeaway is that gold loans should be sanctioned in the banking hall, under the watch of the staff and the public.

Additionally, a photograph of the pledged ornaments should be attached to the loan application form; the customer should sign below the gross and net weight columns; and the joint custodian of the gold should confirm with a signature that the customer has signed in his/her presence below the gross and net weight columns. 

End use of funds: In the list of illustrative deficiencies given by RBI, end use of funds not usually verified for non-agricultural loans and lack of proof of proper documentation obtained for agricultural loans were included. Instructions, if any, issued by the regulator in this regard should be done away with. In foreign countries, even in the case of project finances, end use of funds becomes the responsibility of the beneficiaries, with trigger conditions for violations. Gold loan is basically a consumer loan. In the case of agricultural gold loans, it is enough to obtain a copy of the agricultural land document (to verify that the applicant is a farmer and that the loan is based on scale of finance) and a declaration that the money will be used for agricultural purposes. Penalty conditions — including higher interest, recall of loan, and so on — will trigger if there is a violation. 

Repeat lending and early pre-closures: Gold loans are used to meet emergency needs. Since the ornament pledged often has sentimental value, it is a common practice to redeem them at the earliest possible. 

In fact, the average period of gold loans at banks is 60-90 days. Hence, there is no harm either in granting multiple gold loans to the same individual during a year or in early pre-closures, unless there are other valid concerns.

Renewal of gold loans based on part payments: A liberal overdraft facility (akin to overdraft loans against shares) with review of margin at constant intervals (as gold value varies daily) can be introduced in personal gold loans. As a running facility, it will allow customers to make remittances periodically and withdraw according to need and available drawing power. This may obviate the need to evergreen the loan through part payments. In respect of gold loans extended as overdraft or otherwise, the renewal or enhancement by accepting interest payment alone may be considered favourably as gold value appreciates over time, the loan is fully secured, and gold is an eligible cash collateral for capital adequacy requirements. Gold loan, where the security is with REs and can be set off through auctions without court intervention, must be treated differently from a regular cash credit and unsecured loan. While permitting this relaxation, the ‘evergreening of gold loans’ issue can be addressed by prescribing board-approved policy with adequate safeguards.

While the regulator may prescribe a board-approved policy with safeguards to avoid evergreening of gold loans, it must permit acceptance of part payment, equivalent to the interest portion, at least for renewal or enhanced limit. 

(The writer is former chief general manager, State Bank Group)