Clipped from: https://www.business-standard.com/opinion/columns/gold-loans-reading-the-growth-right-126043001487_1.html
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Illustration: Binay Sinha
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Recent media reports have highlighted the rapid growth in personal gold loans and the potential risks associated with larger-ticket exposures, higher borrower leverage and fluctuating gold prices. These concerns deserve attention, but they also need to be seen in perspective.
Gold loans narrow a genuine credit gap: They give households and small borrowers an easy way to obtain liquidity, using an asset they already hold, often within the formal financial system rather than through informal channels.
That said, a gold loan is still a credit decision, and strong collateral can never be a substitute for sound credit judgement. Repayment capacity, overall leverage, and the purpose of borrowing all matter.
A time-tested form of credit
In India, gold has always meant more than adornment. It has stood for security and reassurance, and a natural hedge against life’s uncertainties. For generations, households have turned to it not only as a store of value, but also as a ready source of liquidity when needed.
Indeed, the practice of pledging gold for credit predates India’s modern legal system. Ancient texts such as the Manusmriti and the Arthashastra refer to secured lending, interest, and loan discipline, showing that gold-backed borrowing long predated modern financial institutions. For much of our history, such borrowing took place outside the formal financial system, often at high interest rates and with little transparency or recourse.
In the late 1950s, banks in southern states began offering gold loans in a more structured manner and at reasonable interest rates. In the following decades, gold loans gained momentum to become a standard loan product, catering to consumption needs as well as agricultural operations. Later, specialised non-banking financial companies (NBFCs) expanded this business through wider branch networks and more customer-friendly practices.
The modern story of gold loans in India is, therefore, not simply the story of a growing financial product. It is also the story of formalisation, of an age-old household practice gradually moving from oral agreement and local discretion to documented finance under a regulatory framework.
Why formalisation matters
This formalisation of lending against gold collateral is a welcome development. It gives households fairer valuation, documented terms, grievance redress and greater accountability, while allowing a widely held household asset to be used productively for genuine needs.
At a time when greater attention is being paid to the pace and quality of unsecured retail lending, gold loans offer an avenue for secured retail credit and can support a healthier mix of retail credit.
A product with natural strengths
Gold loans have certain strengths that explain their enduring relevance. Gold is tangible collateral, capable of valuation within defined norms, with transparent market prices and standard units of measurement. Gold loans allow households to raise finance without permanently parting with an asset of lasting value, faster than through other forms of formal credit.
More importantly, gold jewellery often carries emotional significance that goes well beyond its market price. For many households, pledged ornaments are family assets associated with security and sentiment. That can strengthen repayment discipline and help explain why gold loans have often shown lower stress than unsecured retail credit.
The higher growth in gold loans may also be reflecting something positive: The movement of borrowers from informal sources to regulated entities, the more productive use of household assets, and a healthier balance between secured and unsecured lending for banks and NBFCs.
Strengths do not eliminate risks
Such versatility of the product should not be mistaken for the absence of risk. A modest gold loan used to bridge a temporary need or serve a productive purpose is very different from repeated borrowing layered over existing debt. A real concern arises when a highly leveraged borrower, already servicing housing, consumer or personal debt, turns to gold-backed borrowing as an additional layer of leverage. Concerns multiply when there are concurrent loans, repeated renewals or top-ups, and limited visibility into total indebtedness.
Gold, like any other commodity, is subject to price cycles, and adverse price movements are not uncommon. Prudential safeguards such as loan-to-value ratios and attention to borrowers’ total indebtedness therefore matter, especially in volatile times.
Broadly, the greater vulnerabilities in lending against gold usually arise from weak appraisal, poor monitoring and deficient controls, including spurious collateral, custodial lapses and repeated top-ups. That is where the real regulatory and supervisory perspective must lie.
An old instrument, a mature framework
The Reserve Bank of India’s recent directions address these issues through a harmonised framework for regulated entities, combining calibrated loan-to-value limits, differentiated treatment for income-generating and consumption loans, stronger valuation and custody standards, safeguards for auctions and collateral release, and greater emphasis on credit assessment for larger exposures.
The objective is not to constrain a useful product, but to ensure that, as gold lending expands within the formal financial system, it does so on sound and transparent foundations. The conduct dimension is particularly important in a product that often involves household jewellery of deep personal value. This calls for transparent valuation, clear communication of terms and conditions, proper notice before auction, fair realisation of value, prompt release of collateral after repayment and effective grievance redress. Responsibility for these outcomes ultimately rests with the banks and NBFCs, even when some activities are outsourced.
As lending against gold collateral becomes more deeply embedded and enhances access to the formal financial system, the lending practices must be nothing less than gold standard!
The next phase
Gold loans are entering a new phase in India, where growth can also signal formalisation, better use of household assets and a healthier mix of retail credit. Their long-term strength, however, will rest on sound processes and proper oversight.
A product shaped by history and household practice is now moving into a more coherent regulatory architecture. The aim is to ensure that it evolves in line with modern standards of fairness, prudence and accountability.
The author is Deputy Governor, Reserve Bank of India. The views are personal
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