Indian financial institutions struck gold, quite literally, as the COVID-19 pandemic triggered a surge in loans against jewelry since early 2020.

The pace of growth of such loans may slow as gold prices ease and the stress on household budgets abates. But analysts say that banks and nonbanking financial companies, or NBFCs, may increasingly tap Indian consumers sitting on a $1.5 trillion hoard of the yellow metal as estimated by the World Gold Council, the global market development organization for the industry.

Gold investments in Indian households are mostly in the form of ornaments that are passed down for generations. The World Gold Council expects the gold loans market to grow at an annual rate of 15.7% and reach 4.617 trillion rupees in the fiscal year ending March 2022, from 3.448 trillion rupees in the year ended March 2020.

"Because gold loans are backed by a liquid collateral almost equivalent to cash, the credit risk angle is largely taken care of," V.P. Nandakumar, CEO and managing director of Manappuram Finance Ltd., an Indian NBFC, told S&P Global Market Intelligence. People across India have a traditional affinity for gold ornaments, which makes them sentimentally attached to pieces of jewelry that are often family heirlooms. "This emotional connect with the jewelry acts as a further deterrent to default and it makes gold loans different from any other kind of commodity lending," Nandakumar said.

Demand for gold jewelry slumped 34% to 1,411.6 metric tons in 2020, dragged by mainland China and India, the world's biggest consumers, according to a Jan. 28 report by the World Gold Council. However, demand for loans against gold jewelry in India increased, helped by rising prices of the yellow metal and as household budgets were stressed because of the pandemic. After a dip in the first quarter of 2021, gold prices have recovered in recent weeks. Spot COMEX gold was quoted at $1,865.94 per troy ounce on June 14, compared with $1,941.53 at the start of the year and a record high of $2,063 in August 2020.

"As banks and NBFCs look to expand credit, such loans, taken for both business purposes and emergencies, have gained more attention. [The] gold price rally since 2019 and a bullish outlook have also added to the popularity of this form of credit among lenders and borrowers," Somasundaram PR, managing director for India at the World Gold Council told Market Intelligence in an email.

Financial institutions are also looking at gold loans as a way to access the vast customer base to cross-sell other financial products. The formal sector was previously less effective in luring customers away from the unorganized market for gold loans, mainly neighborhood jewelers who typically double as pawn brokers. Their branches often lacked personnel capable of assessing the value of gold jewelry and the relatively small ticket size was a hurdle. Now, several lenders offer doorstep services for valuations and to complete paperwork.

Consulting firm KPMG said in a 2020 report that the total gold loans outstanding in the organized sector in 2019 was estimated at 5.5% of the total household gold holdings in India. Organized lenders are estimated to account for a 35% of the gold loan market share, with unorganized lenders accounting for the remaining 65%, according to KPMG.

This "presents the organized players with a huge opportunity for growth," Nandakumar said. The organized gold loan market has the potential to double its assets under management within the decade. Manappuram's gold loan assets grew by 24% during 2020, he said.

India's biggest lender by assets, State Bank of India, reported 465.08% year-over-year growth in gold loans to 209.87 billion rupees for the fiscal fourth quarter ended March 31. Bank of Baroda said its retail gold loans grew 152.52% year over year in the fiscal fourth quarter to 11.01 billion rupees.

According to data from the Reserve Bank of India, outstanding loans against gold jewelry among banks rose to 604.64 billion rupees in March from 185.96 billion rupees in early 2020. Total loans at banks grew at a relatively sedate 8.3% over the period.

Lenders in the informal sector typically charge between 18% and 24% annual interest on gold loans, which can rise to as high as 36% for really small amounts. By comparison, state-run banks often offer loans at as low as 7.5% per annum, though the rate is typically higher at NBFCs and private-sector lenders, according to a comparison table on local web portal BankBazaar.com.

However, the organized sector may never capture all gold lending. Banks do not have readily available appraisers of gold at their branches and the hold of the informal sector is still strong, particularly in rural areas. Some customers prefer to avail of gold loans in their neighborhoods and may hesitate to travel long distances while carrying their valuables. The proximity of the lender is often more important more than the rate of interest.

Borrowers often seek gold loans in emergencies, and so the speed of disbursal also matters. Banks need more time to value the gold jewelry as they often rely on external appraisers.

As India recovers from a deadly wave of COVID-19 cases, gold loans for business may get a boost in 2021. "A large part of the gold loans is used for business purposes. We expect them to see healthy growth with improvement in economic activities. Part of the growth will also be determined by prevailing gold loan prices," said Alpesh Mehta, head of research at Motilal Oswal Financial Services.

"The initial phase of economic recovery will be positive for gold loans due to pick up in business activities requiring the urgent need of short term borrowing. Gold will remain a default option in that case," Mehta said.