MANAGEMENT DISCUSSION AND ANALYSIS REPORT
1. ECONOMIC OUTLOOK
In FY 2014-15, the Indian economy emerged as one of the few large economies with a promising outlook on the back of controlled inflation, rise in domestic demand, increase in investments, decline in oil prices and the boost to reforms among others. According to the IMF, India is set to become the world's fastest-growing major economy by 2016 ahead of China. India is expected to grow at 6.3 percent in 2015, and 6.5 percent in 2016 by when it is likely to cross China's projected growth rate, according to the IMF said its World Economic Outlook, January 2015.
In January 2015, the government revised base year from FY 2004-05 to FY 2011-12. It unveiled a new statistical method to calculate the national income with a broader framework that turned up a pleasant surprise: GDP in FY 2013-14 grew 6.9 percent instead of the earlier 4.7 percent. The revision in base year of India's national accounts will increase the size of the economy to 7 111.7 trillion (US$ 1.8 trillion) in FY 2013-14, according to India Ratings. The size of the Indian economy was at about 7 93.89 trillion (US$ 1.51 trillion) in FY 2012-13.
The easing of interest rate cycle has begun with repo rate being reduced by 50 basis points in 2015 as steep fall in global crude oil prices aided in reducing inflation and shrinking the current account deficit. The current account deficit has narrowed consequent to the fall in trade deficit and increase in invisibles. However, even as the trade deficit has shrunk to 17 months low in February 2015, it was accompanied by deterioration in exports growth.
The easing of policy rate should facilitate credit growth going ahead as deployment of bank credit to micro 8 small, medium and large industries (6.6 percent) and services (7.5 percent) moderated significantly in January 2015 as against a growth of 13.6 percent and 17.3 percent respectively during January 2014. The sharp fall in inflation (WPI) aided by the decline in global commodity prices reduces much of the risk to domestic growth. Nonetheless, the slowdown in the commodity prices globally poses a big threat to global growth prospects. This in turn is bound to have some impact on India.
India's foreign exchange reserves stood at a record high of US$ 343.2 billion as of April 17, 2015, having crossed the brvious high of almost US$ 321 billion in September 2011. In recent months, RBI has generally been buying dollars to keep a check on the excessive apbrciation of the rupee which can hinder exports. At current levels, reserves are sufficient to cover imports for eight to nine months.
Decentralisation and setting a target for inflation as per the monetary policy framework agreement between the central bank and the Union government are two landmark changes being ushered in the recent period. The decisive re-shaping of Centre-State fiscal relations through fiscal decentralisation (42 percent share of the divisible pool of taxes will now be transferred to states) will bring about a fundamental change in which development activities will be rolled out in future. All the above proposed measures have the ability to fast track India's growth momentum.
2. SCENARIO FOR NBFCS
The NBFC sector has been gaining systemic importance in the recent years and the share of NBFC has steadily grown from 10.7 percent of banking assets in 2009 to 14.3 percent of banking assets in 2014. NBFCs typically have several advantages over banks due to their focus on nichesegment, expertise in the specific asset classes, deeper penetration in the rural and unbanked markets. However, on the flip side, they depend to a large extent on bank borrowings, leading to high cost of borrowings and face competition from banks which have lower cost of funds.
Revised Regulatory Framework for NBFC:
The rising importance of NBFCs and their growing interconnectedness with banks as well as issues like risk management framework for the sector, regulatory gaps and arbitrages, compliance and governance issues have led to the RBI making certain regulatory changes. The 'Revised Regulatory Framework for NBFCs', released on November 10, 2014, broadly aims at strengthening the structural profile of NBFC sector, wherein focus is more on safeguarding of the depositors money and regulating NBFCs which have increased their asset-size over time and gained systemic importance.
The key changes introduced in the regulatory frameworks are NPA recognition to 90 days overdue from 180 days at brsent and increased provisioning on standard assets which can impact profitability. However, early adoption of these changes will facilitate disciplined approach in asset monitoring and will intensify collection effort in the early delinquency buckets to reduce NPAs thus minimising the impact. The increase in disclosure requirement and corporate governance norms will increase transparency and the accountability of management and the Board and also improve investor awareness.
Due to subdued economic growth, the last two years have been a challenging period for the NBFCs with moderation in rate of asset growth and rising delinquencies resulting in higher provisioning thereby impacting profitability. However, comfortable capitalisation levels and conservative liquidity management continue to provide comfort to the credit profile of NBFCs in spite of the impact on profitability.
GOLD PRICE MOVEMENTS
In January, the London Bullion Market Association (LBMA) forecast an average gold price of 1,211 US dollar for 2015. This is 0.6 percent lower than the average price of 1,218 US dollar in the first half of the month.
The analysts surveyed by the LBMA foresee further brssure on the gold price coming from the potential ncrease in the value of the US dollar, a possible ncrease of interest rates by the US Federal Reserve n the second half of 2015, Quantitative Easing (QE) programmes in Europe as well as a continuing trend of weak oil price. This would likely lead to a diminished demand for a hedge against inflation.
However, some investment professionals are pessimistic and caution investors against the temptation to buy gold. It is argued that one of the main reasons to own gold - the fear of inflation -is so far from being a problem that demand will remain low. Moreover, expectations about the US economy performing well in 2015 will likely continue to weigh down the gold price.
On the other hand, gold price will likely be supported by the strong retail demand from China and India (though only limited support is expected to come from the central banks). Further, any further fall in price will likely lead to a cut back in output of gold as gold mines operating at the margin will be rendered uncompetitive.
Gold prices in India keep track of the international prices after factoring in the additional impact of the rupee-dollar exchange rate and the brvailing customs duty. While international prices had fallen by close to 30 percent in 2013, the decline in India was less at about 10 percent mainly because of currency debrciation and increase in import duty on gold from 2 percent to 10 percent. With the brssure on current account easing during the last year, there followed a relaxation of measures like the 80:20 rule that made traders re-export 20 percent of the gold they imported. However, customs duty on import of gold continues to remain at a high of 10 percent.
4. SCENARIO FOR GOLD LOAN NBFCS
Gold loans in India have been in existence for centuries, in the form of informal institutions such as pawn shops, delivering quick and easy access to loans against gold as collateral. Until a couple of decades ago, gold loans were delivered almost totally through the unorganised sector by private money lenders and pawn brokers typically at usurious rates of interest. However, with the entry of formal financial institutions in the gold loan sector, the market dynamics have changed completely.
Formal financial institutions have introduced innovative gold loan products at cheaper costs, and provide better customer service and they now command a market share exceeding 25 percent. The organised gold loan market has grown at 40 percent CAGR in the period from 2002 to 2010. The gold loan market has emerged as one of the most reliable sources of credit for low-income households. Compared to other sources of credit available to low-income households - such as loans from Microfinance Institutions (MFI), loans from Self-Help Groups (SHGs), or community-based borrowing - gold loans are easily available with minimal procedural requirements. Unlike MFI loans, gold loans can be used for various purposes. This provides flexibility to gold loan clients to use the money for medical expenses, education, or repair of household assets etc., which are important investments that improve the quality of life.
Regulatory environment for Gold Loan NBFCs
During FY 2011-12, India's Current Account Deficit (CAD) became a cause for concern and import of gold was seen as contributing a major share to the deficit. This factor, along with concerns about increased systemic risk arising from the rapid growth of gold loan NBFCs, led the RBI to tighten regulations governing gold loan NBFCs. The intervention had a salutary impact on the sector from a long term perspective in terms of strengthening the ability to withstand price risk, improved customer care, standardisation of processes related to valuation of security etc. However, in the course of adjustment to the tighter regime, growth in the sector was affected and business volumes suffered a marked decline over the following two years contrast, FY 2014-15 witnessed stability in the regulatory environment. There was no material change in the regulations pertaining to gold loan NBFCs. It may be recalled that in January, 2014, RBI had permitted gold loan NBFCs to lend up to 75 percent of the collateral value of gold (i.e. cap on LTV of 75 percent) as against the earlier cap of 60 percent. Further, banks were also made to adhere to the stipulation. A major demand of the gold loan NBFCs—restoration of a level playing field vis-avis banks—was thus conceded.
The recovery in gold loans
Having gone through tough times for a couple of years, during FY 2014-15, gold loan companies regained their footing and succeeded in making their business resilient to gold price volatility. The trigger for the change in fortunes goes back to the decision by RBI in January 2014 to increase the loan-to-value (LTV) ratio to 75 percent (from 60 percent) which levelled the playing field for the NBFCs vis-a-vis the commercial banks. However, growth did not follow immediately due to decline in gold prices and because competition was biting into the market share of gold loan NBFCs. Moreover, gold loan NBFCs carried stressed assets from brvious quarters due to the gold price decline, which led to higher auction of pledged ornaments.
Beginning with the second quarter of the year, there was a marked turnaround with gold loan NBFCs getting back on the growth track. They were helped by the fact that continuing volatility in gold prices had dampened the enthusiasm for gold loans among banks who were now less aggressive than in the past. At the same time, faced with the challenge to regain ground lost to the banks over two years, NBFCs felt a need to offer interest rates closer to what banks were charging. Muthoot
Finance, for instance, offered its "Advantage Gold Loan" with interest rate beginning from 18 percent for a relatively high LTV scheme. Towards the end of the year, Manappuram Finance launched its SY scheme offering gold loans at interest rates starting as low as 12 percent. Moreover, there were focussed efforts to woo back lost customers, who were often contacted personally.
These efforts appear to have paid off and the sector has seen visible growth over the past three quarters. There is now an expectation that the industry will be able to maintain moderate rates of growth in the current FY 2015-16 too, although a return to the peak asset levels of FY 2011-12 is still some way off.
The experience of going through a phase of downturn has not been without blessings. In general, gold loan companies have made their businesses more resilient gold price volatility. This has been achieved by following tighter risk management practices. Interest collection is being given more focused attention and a system of regular, periodical collection of interest has been introduced across the industry.
Structural versus cyclical growth drivers for gold loans
Structural growth drivers:
The following may be considered among the structural growth drivers:
O India has the world's largest stock of privately held gold estimated at about 22,000 tonnes. Importantly, about 65 percent of the total stock is held by rural India. In the absence of financial inclusion, for many Indians gold is the brferred outlet for savings.
O Traditionally gold has been a valued commodity, used for making jewellery, coins, and other articles. When held in this form it does not serve any productive purpose.
O Gold being a highly liquid asset, people have been leveraging it for meeting liquidity needs. However, for a very long time, this activity was overwhelmingly carried out by the unorganised sector (local moneylenders and pawnbrokers) who lacked transparency in their dealings to the detriment of the customer's interests. In recent years, the organised sector (NBFCs and Banks) have entered the business in a big way and brought about a transformation in the way the business is carried on. However, even today, the larger share of the business continues to be with the unorganised sector and, moreover, the bulk of private gold is not monetised.
O There are efficiency gains that result when people are given access to credit speedily and with minimum hassle. Transactions can be put through, and deals closed, with the ready availability of funds from a gold loan.
O With increasing prosperity, tolerance for delays and procedural hassles goes down. Time is money, and this is more acutely realised when incomes rise because people are less inclined to wait in queues or be put to unnecessary hassles. They want things done in a jiffy. A hassle free gold loan from an NBFC offers compelling value in these circumstances.
O Gold loans are typically small ticket loans taken for short durations. Due to the institutional lenders' investment in technology and modern management techniques, they are now a source of convenient and instant credit.
O A 2013 study on gold loans by the Centre for Microfinance (affiliated to IFMR, Chennai) reveals that the choice of a gold loan provider is influenced mainly by availability in the immediate neighbourhood rather than factors like rate of interest, LTV ratio etc. Given that gold loan NBFCs have greater reach compared to banks, it places them at a competitive advantage.
O Internationally, the price of gold has enjoyed a decade long bull run with sustained increases in price till 2012. This aided the growth of the gold loan business in India in two ways. On the one hand, customers could be offered increasingly higher loan amounts on their existing jewellery. On the other hand, it benefited lenders by containing the price risk in the event of default.
Low penetration a key enabler of growth
A report by ICICI Securities in January 2014 notes, "Penetration levels for all players combined (banks and NBFCs) remains low at about 23.4 percent of the potential gold-loan market in India. Accordingly, we do not see a problem with either competitive clutter or with opportunity headroom. Also, remember that our estimate of the opportunity is based on assumption that only 15 percent of the domestic gold stock is potentially up for collateralisation. With 70 percent of India's gold in rural locations with limited banking facilities, the opportunity size may well be bigger."
a. Untapped potential: The core business of the Company, of providing gold loans, continues to offer good growth potential. The World Gold Council (WGC) estimates privately held gold to be anywhere between 18,000 to 20,000 tonnes in India. The gold loans business model aims essentially to impart liquidity to this stock which is still largely untapped.
b. Level playing field: With the RBI now brscribing a uniform cap on LTV of 75 percent for both banks and NBFCs, there is a level playing field which benefits NBFCs. Further, the volatility exhibited by gold price over the last two years has visibly dampened the enthusiasm for the gold loan business among banks which translates into a less aggressive stance in the market.
c. Comparison with microfinance: The average time to receive a gold loan from an NBFC can be measured in minutes/ hours, while a loan from an MFI or SHG takes weeks to get processed. The repayment schedule of MFI/ SHG is either weekly or monthly, whereas the repayment schedules for gold loans are extremely flexible. While gold loans can be used for any purpose, 70 percent of MFI loans have to be used for income generating activities, as per the Micro Finance Institutions (Development and Regulation) Bill, 2011. These consumer friendly features of the gold loan market distinguish it from other sources of credit, thus making gold loan products popular and reliable.
d. Continuing opportunities in the unorganised sector: A study conducted in 2013 by the Centre for Microfinance (affiliated to IFMR, Chennai) reveals that proximity to home is the most widely cited reason for choosing a given type of financial institution when availing gold loan. This implies that people brfer convenience over other factors and also reflects the fact that transaction cost plays an important role in the financial behaviour of a client. While 45 percent of informal clients cited 'proximity to home' as the leading factor for their decision, only 25 percent of formal client cite this factor. This implies that in spite of widesbrad financial services of the formal sector, the informal sector outnumbers the formal sector.
The study also made an interesting observation that clients who consider interest rate and loan to value ratio as the primary factors for choosing a particular type of institution mostly opt for the formal sector. While it is common known fact that interest rate for formal institutions is lower and follow RBI guidelines, it was also observed that clients are finding higher loan to value ratio with formal institutions rather than the informal players. It reflects the changing trend among informal gold loan players as they become increasingly risk averse and therefore less eager to compete on LTV.
e. Expected gains from technology innovations:
The Company is in the process of rolling out an advanced Automatic Intrusion Alert Management System (AIAMS). This is a state-of-the-art centralised surveillance system to reinforce the security of the gold stored at its branches. The system works through sensors located at the branches that are designed to detect attempts at intrusion and deter burglars from targeting the Company's branches.
Apart from deterring burglary and other security mishaps, AIAMS has the potential to replace many of the night guards. It is estimated that the number of security guards employed by the Company can be reduced substantially, translating into significant cost savings over the coming years. Since its launch in November 2014, the Company has already covered over 1000 branches and within the next few months, AIAMS will be implemented at all Manappuram branches in India.
a) Volatility in gold prices
As mentioned earlier, gold price is expected to remain subdued during the year. The fall in the international markets was not fully reflected in the India as there is an import duty amounting to 10 percent applicable in India. An assessment of the threat posed by a scenario of falling gold prices is given below.
Defaults and auction realisation: A declining trend in gold prices can increase defaults as instances of loan outstanding exceeding the value of pledged security rise. Moreover, realising the value of pledged gold of an account in default takes time and the lender is vulnerable to price risk over this period.
In this context, the Company has introduced certain new measures to strengthen its collection mechanism. Borrowers are now encouraged to pay the accrued interest periodically, brferably on a monthly basis. Hitherto, the practice in gold loans was to make bullet repayments of both interest and principal. Also, the Company has introduced loans of shorter tenure, of three, six and nine months, in addition to the standard one year. Earlier, all gold loans were sanctioned for tenure of 1 year which often delayed recognition of default and initiation of recovery procedures.
Impact on business volumes: The gold loans business is not generally dependent on the price of gold. After all, people borrow only because they have needs and these needs are always independent of the current price of the gold in their possession. At the same time, in a scenario of rising gold prices, gold loans tend to do well because it would compare favourably with other loans. When prices fall, the eligible loan amount falls proportionately, and gold loans may become somewhat less attractive as borrowers may resist having to settle for a lesser loan amount than before. Consequently, the Company may see lower growth in a phase of subdued gold price.
b) Change in periodicity of interest collection
Till recently, bullet repayment (of both principal and interest) was the norm for gold loan NBFCs and gold loans found favour for its flexibility. Consequent to the recent softening of gold prices, NBFCs are now calling on customers to periodically remit the interest due, brferably on a monthly basis. It detracts from the flexibility that was the point of attraction with gold loans earlier and to that extent may be seen as cumbersome.
c) Hostility to gold among policy makers
With an increase in the import duty of gold to 10 percent and further restrictions levied by the government on the purchase of gold, gold is increasingly becoming unaffordable for the low-income households. Keepng in view the challenge of financial inclusion, discouragng purchase of gold makes the base of population pyramid even more vulnerable to shocks since gold serves as a medium of financial security for low-income households. While the government aims to bring all households under the ambit of the formal financial sector, it should keep in mind that achieving this would take some time, and gold loans would continue to be important during the transition.
Further, gold is a highly liquid asset and people brfer obtaining gold loans during an emergency situation. However, restrictions on the purchase of gold imply decrease in the demand for gold, leading to a decrease in gold loans. In the absence of alternative financial products, this leaves low-income households with few credit options.
d) Gold as inflation hedge weakens emotional connect
The Indian economy is passing through a high-inflation phase that began around 2006 and has persisted till now. Interest rates on deposits in the banking sector have fallen well behind the inflation rates. Consequently, savers in the economy have been diverting funds away from bank deposits to other assets like real estate, gold etc. Thanks to the prolonged bull run in prices, gold had become an attractive inflation hedge and a lot of people bought gold, not for the traditional reasons, but merely as a protection for savings against inflation. It is likely that when such gold is pledged, borrowers would lack the "emotional connect" and, to that extent, defaults during price corrections will be higher.
7. RISKS AND CONCERNS
The Company has put in place a mechanism to minimise operational risks through effective control systems which call for constant review and an ongoing internal audit. Our risk management framework aims to identify the diverse risks faced by the Company and come up appropriate mitigation strategies. Our Internal Audit Team, which reports directly to the Audit Committee of the Board, undertakes a combrhensive audit of functional areas and operations at all the branches. The Company has also set up an off-site surveillance system to make its internal control systems more risk-proof. Managing the risks arising in credit, interest rates and liquidity form critical components of our risk management system. The Company has in place rigorous norms for credit disbursal through the Lending Policy Framework. An asset-liability management model has been developed to measure and manage interest rate and liquidity risks and these are discussed and reviewed periodically at appropriate forums within the Company.
8. CAUTIONARY STATEMENT
Statements in this report pertaining to the Company's objectives, projections, estimates, exceptions and brdictions are forward-looking statements subject to the applicable laws and regulations. These statements may be subject to certain risks and uncertainties. The Company's operations are affected by many external and internal factors which are beyond the control of the management. Therefore, the actual position may differ from those exbrssed or implied. The Company assumes no obligation to amend or update forward looking statements in future on the basis of new information, subsequent developments or otherwise.