Prolonged drop in gold prices can erode collateral buffers: Fitch Ratings

Bengaluru: Gold prices are down nearly 16% — from Rs 1,73,080 per 10 gram on March 1, to Rs 1,48,690 on March 31 for 24k — due to a surge in oil prices and a strengthened US dollar amid geopolitical tensions.

But this prolonged drop can erode collateral buffers, trigger collateral top-up requests, and raise operational complexity and regulatory compliance risks, according to Fitch Ratings.

An extended correction in domestic gold prices will test the effectiveness of Indian gold-backed lenders’ risk controls, particularly for loans originated when gold prices were near recent highs, Fitch Ratings said.

Gold loans in India are subject to a regulatory LTV (loan-to-value) limit of 75% on the loan principal at origination.

“This implies sufficient buffers to absorb a 25% gold-price decline before principal loss, or a 5%-10% decline if including interest payments of 15%-20% accrued over one year. In practice, lower applied LTVs provide a larger collateral buffer, and effective loan tenors of typically between four and six months reduce the actual interest burden,” it said.

Average LTVs at origination are typically 3%-5% below the regulatory limit, but this has widened to 5%-10% below the cap as gold prices climbed around 5%.

Analysts have said the current strong dollar and higher yields are exerting downward pressure on prices.

Rising gold prices boosted collateral buffers on outstanding gold-loan portfolios, especially on facilities extended in earlier months, and conservative collateral valuation on only the gold content of pledged jewellery, excluding gems and workmanship charges, implies a higher replacement cost and a potentially larger valuation buffer relative to reported LTVs, Fitch Ratings added.

Lenders have also introduced borrower top-up requirements to preserve adequate LTV ratios in the event of falling gold prices.

It said that a sustained decline could translate into higher delinquencies and more frequent auctions, if falling collateral values coincide with weakened borrower cash flow, as remedial actions depend on borrowers’ ability and willingness to provide an additional margin to maintain compliance with regulatory LTV limits. “Recoveries could also become more sensitive to auction timing and local market depth if market participants expect gold prices to fall further,” it added.

Jateen Trivedi, VP Research Analyst — Commodity and Currency, LKP Securities, said gold is likely to stay volatile with limited upside unless clarity emerges on inflation and geopolitics.

“Sentiment remains cautious as macro triggers still favour higher interest rates. Support is seen near Rs 1,42,000, while resistance is placed around Rs 1,46,500,” Trivedi added.

Meanwhile, Axis Mutual Fund in its note mentioned that the gold outlook will depend on how the global macroenvironment evolves.

“If inflation remains elevated due to persistent high oil prices, central bankers may keep liquidity tight — bolstering the dollar and yields, which would cap gold’s upside. On the other hand, if oil prices settle down indicating lower inflation risk, it could rekindle expectations of rate cuts, easier liquidity and a weaker dollar: conditions under which gold typically thrives,” it said.