Gold Backed Loans: Unlocking Liquidity for the Poor?
In some parts of South Asia there is a long standing tradition of accumulating gold as a preferred form of saving. Acquiring gold allows small amounts to be accumulated at different intervals; it is not easily lost or destroyed; it is small and lightweight compared to its value; and it is easily divisible into small units which can be sold off as needed. Gold is often worn as decorative jewelry by women, and is passed on from one generation to the next. Given that it can be easily liquidated, though often with the risk of considerable loss, jewelry shops and pawnbrokers do brisk business in buying or pawning gold.
In regions of Pakistan (Sindh and Punjab provinces) and India (more the south than north), families use gold significantly as a means of savings. So much so that for some segments of society savings in gold greatly outpaces savings via financial products.
Some microfinance institutions have taken notice of what happens with their clients and have added a gold lending product that competes with informal sector options. To provide a better service MFIs have sought to establish systems that are quicker, cheaper, and more reliable. Unlike un-collateralized microcredit lending, gold lending is fully secure. Innovations have less to do with reducing the risk of default and are more focused on convenience to the client.
Tameer Microfinance Bank (TMFB) is a leading microfinance bank in Pakistan that has a gold backed loan portfolio. And most of its gold loan portfolio is in the rural portion of its operations used primarily for agricultural purposes. Kshetriya Gramin Financial Services (KGFS) in India is a non bank finance company that works in remote rural geographies. KGFS is pioneering a new approach to microfinance that assesses and then tries to address the complete financial needs of all households in a given geographic area. Both organizations developed a gold backed loan product after observing household needs in rural areas. And the similarities between the TMFB and KGFS products highlight how both have structured the product to offer something highly valued in their respective markets.
Innovations to provide a competitive gold loan product focus on 4 important components.
1. Valuation – Establishing the value of the gold is essential. TMFB certifies jewelry shops to value gold jewelry; after which the gold item is placed into a sealed and labeled tamper-proof bag for deposit with the bank. KGFS places testing tools and an accurate scale at its branches. In a matter of minutes clients can request KGFS staff to undertake a chemical test which verifies that the gold meets basic minimum quality standards and to weigh the gold to establish its market value. In both cases there is a regularly updated table that establishes the value of the gold and allows staff to make a loan up to 70-80% of the value. The extra margin on loan to value covers extra interest payments or fluctuations in the market price of gold.
2. Processing Time – Borrowers do not have to wait or go through lengthy processes. Once their gold has been valued and placed in a sealed bag, clients can access their cash the same day. There are few, if any, formal sources that would provide a loan the same day meaning the gold loan may be particularly useful.
3. Storage and Tracking – The financial institution’s main responsibility once a loan is consummated is for the safe keeping of the gold jewelry. This requires well developed logistics to prevent fraud or tampering. Each jewelry item is kept in a tamper proof sealed bag that is carefully labeled and kept track of by meticulous inventory tracking systems. In both institutions there is a well developed and high secure means of tracking and storing the gold jewelry.
4. Loan Recovery – The loan term is usually a year or less and borrowers can repay at any time during the loan term and recover their jewelry repaying the loan in full paying only the interest for the period they held the loan. This is unlike many microfinance loans which tend to discourage early repayment. Gold loans can be much more flexible than loans with fixed repayment schedules.
There are some advantages to the client over other credit products. Quick disbursement is a big improvement for clients compared to the days or weeks often required for other loans. The interest rate is lower than un-collateralized loans: both TMFB and KGFS offer their gold loans at an annual interest rate that is 4-6% lower than their uncollateralized loans. The MFIs can keep costs low given that evaluation of loan applications does not require much work; people value their gold assets and are generally very careful when pledging them and in repaying their loans. The cases where either institution has had to sell the gold when borrowers have not repaid is very low.
Another benefit is that the decision to apply for a gold backed loan can be made at any time and is made by an individual or household instead of a more rigid and demanding group mechanism. The amount borrowed is determined by the borrower, up to a limit of about 70-80% of the value of the gold pledged, and the repayment schedule is flexible.
If one believes, as KGFS and TMFB do, that the poor value quick liquidity given the unpredictability of their livelihoods and cash flows, a gold loan product can be a useful tool to unlock the value of an asset. Of course, there are risks for poor people, not least that they borrow more than they can afford to repay, or face a crisis that makes repayment impossible for them, and end up losing a valued asset. This makes it all the more important that an MFI follow transparent processes that explains risks fully and even provides counseling about alternatives. For example, KGFS follows a process of conducting a financial well being assessment of households that leads to tailored advice to each household before it can access the financial services on offer. So when a client comes to the branch to discuss a gold loan, the staff already know the household situation and are in a good position to offer advice. TMFB only offers the gold loan after the clients repayment capacity is well known. TMFB also keeps loans sizes under US $ 1,666 as required by regulations. And all TMFB borrowers are subject to a credit information bureau reference check.
Both TMFB and KGFS have kept the levels of borrower default low, and only rarely resort to selling jewelry. Selling the jewelry is not the goal of TMFB or KGFS, though it is important to acknowledge that holding the jewelry as collateral enables TMFB and KGFS to keep their costs low and convenience levels high. The onus is on TMFB and KGFS to continue to carefully assess borrowers capacity before loans are issued in order that the cases where they are forced to sell the jewelry are minimized (though there may always be a few such instances). TMFB additionally tracks the usage of loan proceeds and sees that a large majority of it goes into investments in income earning agriculture especially in rural areas.
The use of gold as savings is not a prevalent tradition everywhere in South Asia. Some regions of India (the North) or Pakistan (northwest) gold is not much used as a form of savings or collateral. However, in regions where people have accumulated savings for a long time offering a gold loan as one product amongst others can be a service that is easier and quicker for clients as well as expensive , and certainly an improvement on the informal sector options people have long used. Gold loan products would be a useful addition to a menu of wider services providing clients one more valued option to better manage their complex financial lives.