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RBI Directs Banks to reduce exposure to Gold Loan NBFCs

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Pursuant to a circular issued on 18 May 2012, the RBI has directed banks to reduce their credit exposure to a single non-banking finance company (“NBFC“) predominantly engaged in lending against gold collateral, i.e., where such loans constitute 50% or more of the financial assets of the NBFC. Banks are required to reduce their exposure ceiling to such NBFCs from the existing 10%, to 7.5% of their capital funds. RBI has directed banks to reduce their exposure to such NBFC’s to the prescribed ceiling limit within 6 months of issue of the circular.

Additionally the circular directs banks to maintain an internal sub-limit on their aggregate exposure to all such NBFCs.  Banks are free to determine this sub-limit.

Loans against gold, offered by banks, NBFCs and unorganised lenders have seen a steady surge in popularity, since such loans provide liquidity to an otherwise idle asset. The RBI directive comes amid concerns over huge outflow of foreign exchange for import of gold further widening India’s current account deficit. However, it may be argued that increase in gold imports are not fuelled by the popularity of gold loans since such loans are not given against gold bullion or gold coins.

The notification will also further restrict unorganised lending against gold given the revised limit on flow of bank funds towards gold loans.  Local and unorganised moneylenders advance petty loans against gold at high interest rates and subsequently use the same gold to borrow money from gold loan companies at relatively lower interest rates.  While the arbitrage opportunity will continue to exist, the overall funds available to the unorganised gold lending sector to exploit such opportunity will reduce.

Thomas Phillippe [thomas.phillippe@pxvlaw.com]

Aparajita Srivastava [aparajita.srivastava@pxvlaw.com]

Alpa Sood [alpa.sood@pxvlaw.com]

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