In today’s Finshots, we explain what’s wrong with gold loan practices and why the RBI is cracking down on lenders.
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The Story
Something strange happened last year at a few Bank of Baroda (BoB) branches. Gold loans, those supposed to be backed by actual, physical gold, were being disbursed without any gold! Yup, you heard that right. No gold at all.
Sounds crazy, doesn’t it?
Here’s what happened.
Some BoB employees, eager to hit their loan targets, devised a pretty shady workaround.1 They teamed up with a few customers and disbursed loans without any gold as collateral. Then, they blocked the customers from accessing the funds and later changed the repayment dates to make everything look legit.
But no real money was being moved around. The employees simply inflated their loan figures. And when it came to processing fees, they used the branch’s own internal expense account to cover it up.
It wasn’t until BoB’s internal audit team started snooping around that they realised something was off. A lot of gold loan accounts were being closed on the same day they were opened!
Clearly, this wasn’t normal.
But it turns out that this wasn’t just a BoB issue. Earlier this year, the RBI temporarily barred IIFL Finance, another big player in the gold loan market, from disbursing gold loans.2
Why? Well, they were cutting corners, too. They were under-assessing the value of gold, handing out cash loans over the permissible limits… and basically ignoring a bunch of important rules.
Eventually, both BoB and IIFL admitted that there were issues and promised to fix them. But by then, the RBI had its suspicions. So, it decided to dig deeper and look at gold loan practices across the board.
And here’s what it found out a few days ago.
First, the RBI noticed that many banks were outsourcing their gold loan processes to third parties, mostly fintech companies.3 Fintechs are great at making things faster and more convenient. But they were skipping some key steps. For example, many were valuing the gold without the customer even being there!
Then, there was the problem with the loan-to-value ratio or LTV. LTV is the percentage of the loan amount compared to the value of the gold you’re pledging. For example, if you have gold worth ₹1 lakh and the LTV is 75%, you can borrow up to ₹75,000.
But here’s the catch. If the price of gold drops, the value of the collateral (your gold) also drops, and the LTV ratio rises. Let’s say your gold’s value falls to ₹80,000. Suddenly, that ₹75,000 loan is now covered by less valuable gold, making it riskier for the bank. And that’s not a good thing because it can sometimes end up in situations where the borrower owes more than the gold’s worth, increasing the risk of defaults.
To avoid this, banks are supposed to monitor the LTV ratio closely. But some weren’t doing that properly either, and that’s when things started to get even riskier.
And then there was evergreening. This happens when lenders keep fictitiously renewing a loan for a long time without really trying to recover the money. It’s basically keeping the loan alive just to make things look better on paper, but it actually increases the risk of default.
But we’re not done yet.
When borrowers can’t repay their loans, banks usually auction off the gold to recover the money. It’s a last resort, but it happens. However, the RBI found that some customers weren’t always informed about how their gold was being sold or what price it fetched at the auction. Lenders were even almost stealing from customers by not returning the leftover money after auctioning all the gold. Because remember, they could only lend up to the LTV ratio or say, 75% of the gold’s value. So, if they auctioned off the entire gold, they were supposed to return the remaining 25% of what they earned to the customer.
On top of that, there was an odd trend. Many gold loan accounts were being closed right after they were sanctioned. Why would someone take out a loan and close it so quickly?
Suspicious, right?
And then, the RBI found that some people were taking out multiple gold loans under the same PAN (Permanent Account Number) in a single year. It looked like some borrowers were gaming the system.
Yet another big issue RBI uncovered was the valuation of gold. Ideally, when you pledge gold, it’s supposed to be assessed for its weight and purity, and then the loan is advanced based on that assessment. But what if a 20-carat gold ornament is incorrectly valued as 22-carat? That would inflate the value, and the loan amount would be higher than it should be.
For example, IIFL Finance had over 1.9 million gold loan customers, and when it was time to auction off some of these loans, the RBI found that 67% of the cases had discrepancies between the gold’s value and the loan amount.
That’s a huge problem because when the borrower defaults and the gold is auctioned, the buyer will only pay for the actual value, say, 20 carats, not the inflated 22 carats. So, the lender ends up losing money.
Well, the RBI isn’t sitting idly by.
It has given banks and NBFCs (non-banking financial companies) three months to clean up their act. They’ve been told to review their gold loan policies, fix the gaps and monitor their third-party services closely.
But how did we even get here, you ask?
See, gold loans have become a lifeline for many people who need quick cash. Borrowers, often typically borrow between ₹60,000 and ₹1 lakh in urgent situations, and they’re usually not in a position to negotiate much.4 They just take whatever terms are offered.
This informality in the sector became especially problematic after the COVID-19 crisis. Back in August 2020, the RBI raised the maximum LTV ratio from 75% to 90% to help people in financial trouble. But even though this grace period ended in March 2021, many lenders just kept operating at this higher LTV ratio, and things spiralled from there.
Also, you see, the gold loan market is now worth ₹6 lakh crore, three times what it was a decade ago. Besides, in the last three years itself, the gold loan market has grown at an annual rate of a whopping 23%! Gold prices have shot through the roof too. In April 2024, gold hit an all-time high of ₹73,000 per 10 grams, a 21% increase in just one year and currently, it is at close to ₹78,000. When gold prices rise, people are more likely to use their gold to secure larger loans at better LTV ratios.
Plus, since gold loans are secured, they are often cheaper than personal loans. The process is simple too. There’s less paperwork, and some lenders even offer to come to your doorstep to finalise the loan.
But with this boom came intense competition.
Once dominated by NBFCs, the gold loan market is now seeing banks fight for a bigger share. Banks jumped in when the RBI raised the LTV cap to 90% for retail gold loans. That’s because they have an edge in agricultural gold loans, where they can lend up to 85-90% of the gold’s value. They can also offer lower interest rates, around 9% to 17%, while NBFCs often charge between 20% and 26% because of their higher borrowing costs. This is partly because NBFCs usually borrow from banks themselves, which raises their expenses.
However, NBFCs can move faster, thanks to internal gold valuations. On the other hand, banks rely on external, government-certified valuers, slowing down their process.
The end result was that this cut throat competition, combined with rising gold prices, translated into riskier lending behaviour. Lenders came under pressure to capture market share and meet their targets. And that drove some of the frauds and irregularities we’re seeing today.
So yeah, the gold loan market is at a turning point as competition heats up and the RBI steps in. But the question lingers ― will lenders clean up their act and prioritise ethical practices?
Only time will tell.
Until then…
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Story Sources: Livemint [1], Business Today [2], The Economic Times [3], Businessline [4]
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