Amidst falling gold prices
Sri Lankan banks are likely to counter the risk of falling gold prices by topping its margins against the collateral whilst a continuous decline in gold prices is expected to reduce the financial system’s dependency on pawning as a method of increasing asset yield in the short to medium term, a recent report by a local brokerage firm has suggested.
According to an Economic Update released by C T Smith Stockbrokers (Pvt) Ltd last week, with gold prices falling by 23% in the second quarter of 2013 (although rising 4% during July 1, 2013 to July 15, 2013), there have been growing concerns related to the deteriorating collateral (gold) value against pawning disbursements, as it tends to increase the average Loan to (collateral) Value (LTV) of a financial institution’s pawning book.
Consequently, the report says that the LTVs of pawning portfolios of all financial institutions are expected to deteriorate significantly (as at end March 2013, when gold prices were at around US$1,600/oz, the financial sector average LTV of pawning facilities were estimated at around 80%-85%), although margin topping up should take place during 2H2013.
“Nevertheless, with no legal recourse available for financial institutions upon default of such a pawning facility (other than auctioning the gold under consideration), local financial institutions have recently increased the margin maintained for pawning facilities disbursed, resulting in average system Loan to Value reducing to 60% - 70% at present from as high as 80% - 90% in the past. This is expected to help local financial institutions to increase their average collateral value vs. pawning disbursements (i.e. the blended LTV of the pawning portfolio) in the near term,” the report titled ‘Gold backed lending and allied risks of the Sri Lankan financial system’ stated.
It noted that in addition, amidst declining gold prices, a financial institution will also seek to adjust the principal disbursement when a pawning facility is rolled over. For example, for a loan given at Rs.45,000 per sovereign 12 months ago, a customer should repay interest and Rs.15,000 today as part of the capital adjustment, since the bank can only give Rs.30,000 now (i.e. topping up the margin).
“The tendency to default on a pawning facility increases in a declining gold price environment as the value of collateral declines below the pawned loan value and as margin top up requirements kick in,” the report said, however, adding that Non Performing Advances (NPA) in pawning operations are not expected to pose a serious issue on the Sri Lankan financial system owing to the short tenor of pawning and dilution of blended LTVs.
“The pawning NPA percentage of the local financial system is expected to have a relatively weak negative correlation with gold prices in Sri Lanka. Furthermore, the recent 10% duty which was imposed on gold imports with effect from June 21, 2013 would likely have a mild positive impact on the Sri Lankan financial system in the medium term as the move is expected to marginally increase local gold prices compared to international gold prices,” the report highlighted.
Meanwhile, CT Smith Stockbrokers in its report also said that most financial institutions had declined to provide up-to-date information on the LTVs and NPA % of their pawning portfolios for their research.
“However, we believe the NPA levels of gold backed portfolios of Sri Lankan financial institutions could rise to around 3% (from historical levels of around 1%) if gold prices fall further to $1,000 per Oz. This scenario, however, is contrary to what is currently experienced in the Indian NBFI sector that offers relatively larger volumes of gold backed loans at much cheaper rates (of 12% p.a.). Manappuram Finance and Muthoot Finance, two of India’s biggest gold loan NBFIs, saw their NPA % rising above 7% YoY by the end of March ‘13 amidst the recent decline in gold prices.”
With gold perceived to be a safe haven investment amidst the multi-year bull run in gold up to late 2011, Sri Lankan financial sector participants, namely Licensed Commercial Banks and Non-Bank Financial Institutions had increased their respective exposures by 25% - 50% in gold backed lending (i.e. pawning) during the past four to five years. Consequently, pawning became popular amongst financial institutions as a means of increasing asset yield. Due to the ease of disbursing such facilities, pawning was largely treated as an OTC (Over the Counter) product. This resulted in pawning facilities gaining more popularity amongst the general consumer during the past few years, especially due to the absence of any need for guarantors and enhanced speed of disbursement.
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