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Can Bharat get cheaper credit by digitizing gold?

LiveMint logoLiveMint 25-09-2017 Sahil Kini

Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”—Warren Buffett

The world’s greatest investor is known to hate gold as an investment. Bharat on the other hand, has a well-documented and almost unhealthy obsession with gold. At a massive 20,000 tonnes, India’s households hoard more gold than any other country on the planet.

Needless to say, this is a massive drag on our economy. A trillion dollars in value, sitting idle as a dull yellow metal. That’s the cash equivalent of four demonetizations (Rs14.5 trillion of cash was demonetized) and constitutes 11% of India’s household assets —compared to less than 1% for pretty much every other country. It’s no surprise then, that 30% of the world’s gold demand comes from India.

So why is it that Bharat loves gold so much? A Reserve Bank of India (RBI) report regarding gold loan NBFCs (non-banking financial companies) weighs in on this matter.

“To make a candid submission, as of now, there appears to be no close substitute to wean away investors’ attention from gold in terms of the returns, liquidity and ease of undertaking operations.”

And while the returns on gold don’t match those of financial instruments like ETFs, it is unmatched on liquidity and ease of transaction. Both qualities that are crucial needs in Bharat.

That being said, there is a way households in Bharat can have their golden cake and eat it too. They can retain the benefits of liquidity and simplicity while “financializing” their gold holdings. By leveraging gold as collateral for credit, households can lower their cost of borrowing by at least 5% in absolute terms. It is the easiest way to generate tangible financial returns from an otherwise idle commodity.

Bharat will always buy gold for a multitude of reasons. Instead of letting it sit in our tijoris (vaults), using gold as collateral ensures it is put to economic use on a continuing basis. The idea of a gold loan is hardly new. Several companies have built gigantic businesses on financializing India’s thirst for gold.

Between Mannapuram and Muthoot, India’s largest gold loan companies hold more gold than entire countries like Australia, Sweden, and Singapore.

Their gold holdings have grown 25% in three years from 195 tonnes to nearly 263 tonnes towards the end of September 2016.

Despite their tremendous scale (both are billion dollar companies), their holdings constitute less than 2% of the country’s total. This means that there’s serious headroom for growth.

If we were somehow able to digitize Bharat’s household gold holdings and link it to our respective credit profiles, it would lower interest rates, thus enabling affordable credit for hundreds of millions.

One can dream of a day where India’s largest jewellery chains such as Tanishq would offer “gold digitization schemes” where anyone with bullion like coins or bars can walk into a branch and “digitize” their holdings.

This would be the equivalent of a gold demat account, where instead of dematerializing share certificates, one would be doing it with gold. This would help the household retain all the benefits of having gold in their tijori, while making it easier to pledge as collateral.

It would be the next logical step for an app like Paytm. They have already sachetized the gold buying experience by allowing customers to buy gold in Re1 increments, and provided tangibility by enabling physical delivery of gold on demand.

Now imagine if they would partner with someone like Tanishq. Anyone could then walk into a store and “digitize” their gold. This digital gold holding would be tied to your credit profile, which you can share with an NBFC/lending entity to lower your cost of credit.

The digitization platform would earn transaction revenue across the chain in such a scenario.

How big could such a company be? Well Muthoot Fincorp, which is the largest of the gold loan companies currently, controls about 25% of the organized gold loan market and has revenues of approximately Rs6,000 crore, and a market cap of Rs19,500 crore.

But this is in a market that accounts for only 2% of India’s household gold holdings. If we take into account the headroom for growth, one could easily imagine a digital challenger building a billion dollar revenue company with even better unit economics. By leveraging eKYC, eSign, and paperless digital contracts, the app-based product will be able to on-board and service customers at a fraction of the cost.

Gold loans have typically depended on pure asset security to manage risk. In other words, it didn’t matter how much you earned. If you brought in Rs1 lakh worth of gold, you would get a max of Rs75,000 as a loan (because of 75% loan to value ratio cap mandated by the RBI for gold loans).

However, if you combined this asset security with data on the transaction history of a customer, NBFCs could to provide larger loans while managing risk.

In other words, a digital gold loan NBFC could potentially lend Rs1.25 lakh against the security of Rs1 lakh at the same interest rate, essentially enabling a resident of Bharat who owns some gold, access to more credit at affordable prices.

Gold is a useless yellow metal in our tijoris (safes). But if we were to digitize it and leverage it, that yellow metal can be very malleable.

Possessing gold acts as a long-term hedge against inflation, and as a reliable store of value. In a nation with two economies, its interoperability will mean it has eternal appeal. But when used correctly in the digital world, it can make Bharat that little bit richer on a day to day basis.

Sahil Kini and Ayush Bhargava are VC investors at Aspada Investment Advisors. The Bharat Rough Book is a weekly column on building businesses for the mass markets represented by the middle of India’s income pyramid.

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