Muthoot Finance, Manappuram well-placed to adapt to new gold loan rules: Fitch

Fitch Ratings on Tuesday noted the Reserve Bank of India's (RBI) draft guidelines for gold-backed loans are likely to improve regulatory transparency and simplify compliance procedures for lenders. The agency pointed out that although the suggested measures may add to operational intricacies, especially for smaller players, established gold-loan specialists like Muthoot Finance Ltd and Manappuram Finance Ltd are well-equipped to adapt to the new requirements.

Last week, the central bank introduced new guidelines to regulate the gold loan sector, aiming to enhance customer protection and increase market transparency. These changes arrive amidst previous concerns regarding irregular practices within the industry. 

A key aspect of the new guidelines is the requirement for lenders to provide broader disclosures about the performance of their gold-backed loan portfolios. Fitch Ratings suggested that these measures will likely improve market transparency, although they could also add procedural complexities, particularly for smaller financial institutions.

The guidelines were announced in conjunction with the recent Monetary Policy decisions, which included a reduction in the repo rate by 25 basis points. Notable proposals encompassed linking loan amounts to the borrower's repayment ability, implementing clearer guidelines on calculating the loan-to-value (LTV) ratio, and conducting income checks for personal loans as well as cash flow checks for business loans backed by gold. 

Fitch has expressed concerns that these requirements might deter non-bank financial institutions (NBFIs) from offering such loans due to the cumbersome underwriting process. 

Fitch stated: "We believe NBFIs are less likely to offer such loans, as the underwriting process may be too cumbersome. The draft rules do not specify whether NBFI loans to sole proprietors for working capital would be classified as income-generating loans, but if so, this could significantly slow an important source of credit to the rural economy."

Large gold loan providers like Muthoot Finance Ltd and Manappuram Finance Ltd are reportedly well-positioned to adapt to these regulatory changes, as noted by Fitch. Despite the potential increase in operational complexity, these companies are expected to handle the transition effectively, unlike smaller players who may face more significant challenges. Fitch predicts that while the guidelines might strengthen oversight in the rapidly expanding gold loan segment, they could also introduce additional procedural burdens for NBFIs, which dominate this market space. 

The draft guidelines mandate a cash flow-based assessment for income-generating loans, a move that could discourage many NBFIs due to its complexity. The uncertainty regarding whether loans to sole proprietors for working capital are classified as income-generating loans is another factor that could affect credit access, especially in rural areas. Furthermore, the new rules stipulate a 1% provision requirement if loans breach LTV limits. Fitch commented on this provision, stating: "This acknowledges that it can be difficult to rectify LTV breaches through collateral calls or repayment notices when gold prices decline. The amount is also manageable relative to net interest margins, but the measure will make credit costs and profitability more sensitive to collateral price falls."

These changes in regulatory requirements reflect the RBI's commitment to unifying a fragmented set of older rules while maintaining existing restrictions, such as the need for RBI approval for NBFIs with over 1,000 branches to expand further. Fitch's observations suggest that while the guidelines are aimed at improving the sector's transparency and customer protection, they might pose challenges in operational execution, particularly for NBFIs.