Breakingviews: Abandoned gold loans are India's "jingle mail"

SINGAPORE Mon Mar 25, 2013 10:54am IST

A gold jewellery shop owner arranges ornaments at a counter in Kolkata May 27, 2010. REUTERS/Parth Sanyal/Files

A gold jewellery shop owner arranges ornaments at a counter in Kolkata May 27, 2010.

Credit: Reuters/Parth Sanyal/Files

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SINGAPORE (Reuters Breakingviews) - The myth that Indians' love for gold is driven by tradition rather than financial self-interest has been dashed. Falling prices have prompted borrowers who took out loans secured against the yellow metal to break a cultural taboo and abandon their collateral. It's the Indian equivalent of American homeowners who walked away from their underwater mortgages by mailing the keys to their homes to the bank.

India's version of the "jingle mail" came to light when Manappuram Finance, a lender against gold, recently warned that defaulting borrowers would force it to report a quarterly loss. The lender's Mumbai-listed shares tanked 31 percent over just three days. The precipitous fall was partly due to concerns the company had selectively leaked its guidance - a charge Manappuram denies. But clearly the lender, which was forecasting a profit as recently as February, had underestimated the borrowers' response.

Borrowing against gold is popular among those who have trouble getting conventional loans. The formal gold loan market has about $30 billion in assets; the pawnshop-dominated informal market is probably several times as large. As recently as the fourth quarter of 2011, companies were offering to lend $100 against jewellery valued at just $110. With annual interest rates at around 26 percent, it only made sense to repay the loan if the value of the gold had risen to $126. But the local-currency price of the same gold has now fallen to about $105.

Last year, the RBI acted to contain the risks. It restricted finance companies from making loans exceeding 60 percent of the value of gold held as collateral. But deals that were struck at higher loan-to-value are now under water. Lenders have little choice but to seize the collateral, and take the hit to their earnings.

In January, a panel set up by the central bank recommended loosening loan-to-value ratios on gold-backed credit to 75 percent. The ongoing fiasco shows that any such move could be fraught with risks. It isn't the subprime borrowers who pose a threat to the system. They will simply behave in their self-interest. It is the lenders' ability to act in the interest of their shareholders that can't be taken for granted.

CONTEXT NEWS

- Shares in Manappuram Finance, an Indian finance company that lends money against gold, fell 31 percent between March 19 and March 21 after the company forecast up to a 500 million rupee loss in the current quarter.

- The lender says it may not receive 2.5 billion rupees or about half of the interest it has earned on its gold loan book of 15 billion rupees as it anticipates some borrowers will default strategically and not redeem their pledged gold, which now costs less than it did between October and December 2011, when most of the problem loans were made.

- In a March 21 statement to the National Stock Exchange in Mumbai, the company denied allegations that it had disclosed the projected loss selectively to one analyst on the afternoon of March 18, a day before discussing the earnings guidance with investors on a conference call.

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)

(Editing by Peter Thal Larsen and Katrina Hamlin)

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