Should gold loans be banned?

Nov 30 2012, 10:30 IST
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RBIís decision to ban bank financing of gold for speculative uses has raised several implementation issues. While there is a need to cap funding for speculation, gold remains an important source of financing for individuals and SMEs. (Reuters) RBIís decision to ban bank financing of gold for speculative uses has raised several implementation issues. While there is a need to cap funding for speculation, gold remains an important source of financing for individuals and SMEs. (Reuters)
SummaryGold remains an important source of financing for individuals and SMEs.

Tanushree Mazumdar

RBIís move to prohibit bank financing of gold comes as no surprise. the question is, will it work? is there a mechanism to segregate the speculators from those who genuinely need money against gold?

The fact that gold gave an annual return of about 36% in 2011-12 only consolidates goldís position both as an inflation hedge as well as an investment asset. However, nobody is going to argue that rising imports of gold (in 2011-12, it was 72% of Indiaís current account deficit) is not a cause for worry.

There is also a case for squeezing Indiaís appetite for gold as there is precious little that can be done in the short term to squeeze the demand for the other major importóoil. There are other statistics that are worrying. Gold loans have grown by a CAGR of around 40% in the last decade when non-food credit of banks has seen a CAGR of 24%. Not to mention the fact that gold stocks in the country have grown by 20% CAGR in this period with more than 60% of the stocks being held in rural India. Investment in gold does not create jobs in the economy, and that is worrisome.

Therefore, the latest move by RBI, of prohibiting bank financing of gold (especially buying gold at auctions or for speculative reasons), does not come as a surprise. Especially coming as it does on the heels of the move in March this year by the central bank to cap the loan-to-value ratio of gold loans extended by NBFCs. The question is how effective will this latest move be? For example, is there a mechanism in place by which banks can identify the speculator category of borrowers from those with genuine need for money against gold? The circular prohibits banks from making advances against gold/bullion if such advances, according to the concerned commercial bank, Ďare likely to be utilised for purposes of financing gold purchase at auctions and/or speculative holding of stocks and bullioní.

It is well-known that, in financial markets, speculators are a category of market participants who merely have a view on the prices and donít really have exposure in the physical market. Their main contribution to the market is liquidity. Thus, even without holding an ounce of gold, it is entirely possible to speculate on gold prices and non-availability of bank-finance need not necessarily restrain such speculation on gold. Unless the circular is

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