RBI allows gold loans against gold jewellery, ornaments and even gold coins (up to 50 grams). However, RBI does NOT allow loans against gold ETFs, gold mutual funds, digital gold, or any other form of financial assets backed by primary gold.
And this is very crisply mentioned in the RBI Master Circular on gold loans. Sounds a bit strange. Doesn’t it? Why would RBI differentiate between different forms of gold holding? In this post, let us look at some of the possible reasons.
#1 Different regulators
The bank loans are regulated by the RBI. SEBI regulates gold ETFs and gold mutual funds.
Since gold ETFs and gold mutual funds are not under RBI purview, it does not control the infrastructure around these products. This could be a source of discomfort for central banks.
However, this does seem like a weak reason.
#2 Enforcing security may be difficult
In case of a conventional gold loan, banks take custody of the collateral. They hold the collateral in their vaults and sell to recover the loan amount and unpaid interest in case of a default.
Now, banks can also sell gold ETF or gold mutual fund units in case of default. However, there are a few issues.
- The gold ETF may not be sufficiently liquid. The bank may struggle to sell units or sell those at the right price.
- There may be a difference between the NAV (intrinsic value) and trading price of the ETF. This can happen in ETFs with lower liquidity.
- What if there is fraud? What if the financial asset supposedly backed by gold is later found not to be backed by gold? This is more of a concern with digital gold sold by online platforms like Paytm etc. These platforms are unregulated and more susceptible to fraud. This is less of a concern with gold ETFs or gold mutual funds because SEBI strongly regulates these. Still, from the RBI or lender perspective, the collateral is not as pristine as holding gold in your vaults.
#3 No direct one-to-one mapping to gold price
A bank lends against 100 grams of gold jewellery. Even after 5 years, the bank. will hold 100 grams of gold as security.
On the other hand, gold ETFs and MFs have fund management and distribution expenses. These costs eat into the returns of gold ETFs and mutual funds, and you can expect the price of gold ETFs/MFs to underperform the price of physical gold.
Hence, even if you gave gold ETF units whose value was the same as 100 grams of gold at the time of loan, the value of the collateral will automatically be less than 100 grams of gold after some time because of tracking difference. Not comforting to the banks.
#4 Curbing speculation and leveraged gold purchases
This, to me, seems the strongest reason of all.
- You borrow against gold ETFs/gold mutual funds.
- Use the loan proceeds to further invest in gold MFs/ETFs.
- Pledge these freshly bought gold ETF/MF units to borrow more and buy more units. And the cycle goes on.
Such borrower behaviour can cause multiple problems.
If this happens on a large scale (and this can happen when gold price is rising), this can lead to market volatility and possibly hurt banks seriously to if gold price were to slide sharply.
Additionally, when you buy gold MFs/gold ETFs, the AMC (or the mutual fund house) must go and buy actual gold to back it. And this is a problem. During upswings in gold prices, more investors/borrowers may indulge in such speculative bets, unnecessarily putting stress on the current account deficit.
There may be clauses in your loan agreements that prevent such leveraged purchases of gold ETFs and gold MFs, but such clauses are difficult to enforce.
Copying excerpt from HDFC Bank Loans against securities terms and conditions.
Hence, RBI has just nipped the matter in the bud by disallowing lending against gold MFs and ETFs. This automatically kills any prospect of multi-layered leveraged purchases of gold MFs and ETFs.
In fact, this could also be the reason that RBI prohibits lending against primary gold. Primary gold has low friction and if allowed, borrowers can soon build leveraged bets in gold (which further increases demand for gold). Gold jewellery and gold ornaments have making charges (costs) which introduces friction and makes such leveraged purchases unviable beyond a point.
This also explains why RBI may not be comfortable allowing gold ETF or gold MF units for loans against security just like equity shares. After all, shares also face problems of liquidity or potential sharp price declines. RBI could have allowed banks to lend against gold ETFs/MFs albeit with a higher margin. For gold loans, LTV can go up to 85% of gold value in the jewellery. RBI could have allowed LTV of 40-50% for gold ETFs/gold MFs (to compensate for higher risk), but then the borrowers could still use loan proceeds to purchase more gold ETFs/MFs.
But you can borrow against your Sovereign Gold bonds
Some of these problems would apply to Sovereign gold bonds, but RBI allows loans against Sovereign gold bonds (SGBs). For instance, liquidity may be a challenge in case of Sovereign gold bonds too.
Then, why this differential treatment? A few reasons that I can think of.
Firstly, while gold bonds do trade on the stock exchanges, these bonds are regulated by RBI. Hence, no different regulatory silos.
Secondly, sovereign gold bonds are not backed by underlying gold (and hence circumvent RBI restriction). SGBs are government securities backed by the Govt’s promise to pay you the prevailing price of gold at the time of maturity. Zero fraud risk. Plus, when gold bonds were launched, the idea was to bring SGBs at par with holding physical gold. Since you could borrow against your gold jewellery, this facility was extended to gold bonds as well.
Thirdly, since SGBs are not backed by gold, there is no concern around leveraged speculative bets hurting current account deficit.
Finally, gold bonds have defined maturity of 8 years. And there are provisions for premature withdrawals as well after 5 years. Hence, there is automatic liquidity after a few years.
However, RBI has stopped fresh issuances of gold bonds and this question of differential treatment for gold MFs/ETFs and gold bonds will automatically go away when the last set of gold bonds matures in early 2032.
As we have seen, different forms of gold investments are not the same from a lender’s perspective. RBI has valid reasons (curbing speculation, controlling risk in bank loan books, and managing current account deficit) for differential treatment for gold ETFs and gold mutual funds.