Non-banking financial companies (NBFCs)1 specialising in gold loans are expected to see their already healthy profitability rising in the medium term with average return on managed assets (RoMA) estimated in the range of ~4.25– 4.5% through this and next fiscal (refer to chart in annexure).
The rise in profitability will be supported by strong demand, improving operating leverage and low credit losses even as competition from banks and other NBFCs increases.
Strong demand prospects and continued low level of credit losses have enhanced the attractiveness of the gold–loan business, drawing increased competition from banks and diversified NBFCs.
Says Aparna Kirubakaran, Director, Crisil Ratings, “An expansion in the lender base and intensifying competition have moderated asset yields in recent quarters for gold–loan NBFCs, though they remain higher relative to many other secured businesses. While the impact on net interest margins (NIMs) has been offset by softening of borrowing costs this fiscal, overall profitability has found support from better operating leverage on the back of a surge in demand.”
Assets under management (AUM) of gold–loan NBFCs are expected to grow at an annualised rate of ~40%2 between this fiscal and next, significantly outpacing branch additions. In the first nine months of this fiscal, branch productivity rose ~30% for these entities. For large gold–loan NBFCs, average AUM per branch shot up to ~Rs 21 crore, while for mid-sized counterparts it rose to ~Rs 11.5 crore.
A large part of the growth this fiscal is attributable to a sharp increase in the gold prices over the past one year. Further, a shift in demand away from unsecured credit to gold loans and recent regulatory developments affording higher loan-to-value norms and flexibility on branch network expansion will further support growth prospects.
Larger gold–loan NBFCs are better positioned to capitalise on operating leverage, aided by strong franchise strength, higher business volume per branch and continued investments in technology and centralised operations. Their scale enables more efficient absorption of fixed costs.
On the other hand, mid-sized gold–loan NBFCs, many of which have been increasing branches to capture incremental demand, may continue to have relatively elevated operating expenses in the near term.
That said, as branch networks scale up and productivity improves backed by strong credit demand, operating leverage is expected to improve further for mid-sized NBFCs. Besides, these entities continue to focus on Tier 2 and 3 markets, where they have an established presence and where competition from banks and large, diversified NBFCs is lesser.
Says Prashant Mane, Associate Director, Crisil Ratings, “Benign credit costs are another driver of profitability for gold–loan NBFCs. Losses have been historically low because of the collateralised nature of these loans, high liquidity of the underlying precious metal and well-established auction processes. Credit costs have stayed below 1% over the past 5 fiscals and are expected to remain low. While elevated gold prices over the past year have further strengthened collateral buffers, structural safeguards such as prudent loan-to-value norms and timely auctions should support recoveries in case of correction in gold prices.”
Overall, the profitability of gold–loan NBFCs is expected to be healthy over the medium term. Larger players are better placed to sustain their stronger metrics on returns, while for mid-sized ones, continued focus on operating efficiency will be key to improving profitability as they expand. That said, growing competitive intensity, potential volatility in gold prices and lenders’ sustained emphasis on prudent risk management as portfolio scales, will bear watching.