Manappuram and Muthoot are the most profitable NBFCs in India. You can see this from Figure 2 of an earlier post here. I’m using return on assets (ROA) as measure of profitability. ROA is the core profitability of the business without taking leverage into account. For FY18, the ROA of Manappuram and Muthoot was 4.8% (5.5% in FY17) and 5.5% (3.8% in FY17) respectively. The ROA for Manappuram and Muthoot for H1 FY19 was 4.6% and 5.6% respectively. An ROA of 2% is generally considered respectable for financial institutions and anything close to 5% is unheard of. So, the question is – what is so special about these two companies and what is the secret to their supernormal profitability and is it sustainable?
The gold loan NBFCs have a product which is highly customized to their target customers and fits them like hands to a glove. In the language of tech companies, they have achieved a superior product-market fit, which is the reason for their extraordinary profitability.
So, who are their target customers? To understand that, let us look at the average ticket size of their loan. This was INR 32,000 for Manappuram at the end of Dec 2018 and although Muthoot did not disclose it, I suspect it is similar for them as well! Yes, you read that right – the average loan amount for gold loan NBFCs is 30-40k. These are generally folks who belong to economically weaker sections of the society. They are not financially sophisticated and are underserved by the current banking system. They can be rural or urban.
What about the product. So, the product is of course a loan but with special characteristics as described below.
- Branch close to the customers: since their customers are not tech savvy, they need to have a physical branch close to where their customers live. Manappuram and Muthoot have ~ 3,300 and 4,400 branches respectively pan India.
- Quick turnaround: since many of the loans are required on an urgent basis, these customers prefer a quick turnaround time. Gold loan NBFCs are able to sanction a loan within a time of 10 mins. On the other hand, banks can take much longer to disburse the same loan.
- Disbursal in cash: again due to the customer segment, many of them prefer loan disbursal in cash. Gold loan NBFCs can disburse the loan in either cash (only upto INR 20,000) or cheque. Banks don’t disburse loans in cash.
- Interest back-ended: Gold loan NBFCs have the bullet repayment of both interest and principal at the end of the loan tenure instead of monthly interest payments (for loans less than INR 2 lakh and tenure upto 12 months). Banks in general require monthly interest payments and in most cases monthly principal payments as well. Additionally, NBFCs don’t charge any pre-payment penalty while banks do.
- Documentation: Gold NBFCs don’t require complete KYC but only minimal documentation for the loan while banks are required to complete full KYC.
- Loan to value (LTV): NBFCs generally offer loans of 75% LTV while banks generally offer 60-65%.
As can be seen, the loan offered by gold loan NBFCs are highly customized to their target segment. Gold loan NBFCs are focused on this segment and their entire operations are geared to make this process quick and hassle free for their customers. Banks on the other are bogged down by their systems and processes and hence find it difficult to match the efficiency of gold loan NBFCs. Because of this, the customers are willing to pay higher rate of interest for loans from NBFCs. The rate of interest charged by the gold loan NBFCs is 18-26% as against 12-15% for banks. Since most of these loans are of small amounts, the difference in interest between a bank and NBFC is more palatable to borrowers. These borrowers prefer the convenience of the loan offered by the NBFCs and are not so sensitive to the rate of interest.
Then there are customers who are sensitive to the rate of interest. These are generally financially sophisticated customers and as a result, prefer to borrow from the banks. Of the total organized gold loan market in India, one-third is with NBFCs and two-third is with banks. But, the total organized gold loan market is only ~25% of the total gold loan market. The remaining 75% is still with moneylenders and pawnbrokers and we will see later why this is so. The interest rates in the unorganized sector range from 25-50% or higher.
Gold loan NBFCs have managed to build a niche for themselves between the banks on one side and unorganized moneylenders on the other. Is this a niche which they can defend? It depends on multiple factors including regulatory framework, competitive landscape and price of gold.
Financing is highly regulated business and gold loan NBFCs are disproportionately affected by regulatory changes. Their competitive advantage can be weakened by regulatory changes. There are precedents of regulatory changes in the past which have adversely affected gold loan NBFCs.
- In March 2012, the RBI reduced the LTV for NBFCs with gold loans more than 50% of their AUM to 60% from 75%. This was a dampener for gold loan NBFCs as their customers could defect to either banks or moneylenders. Banks could offer LTV of upto 75% and moneylenders being outside of regulatory framework face no restrictions at all. This RBI regulation was changed in January 2014 when the LTV for NBFCs was restored to 75%.
- In March 2017, RBI restricted cash disbursement for gold loans to INR 20,000, which earlier was INR 1 lakh. Again, this weakened the competitive position of gold loan NBFCs for their target customers. These customers can approach moneylenders who are outside regulatory framework with no such restrictions.
- Although this has not happened, but theoretically the regulator could also cap the interest rate which charged to the customers for gold loans.
As we saw above, gold loan NBFCs face competition from banks and moneylenders. Lets look at the banks first. While the customers of gold loan NBFCs will defect to banks due to two reasons. One, if their product is copied by competition which means the banks start offering the convenience of the gold loan NBFCs. Two, their target customers become price sensitive as they become more financially savvy. Both of these may happen but I would imagine it will happen gradually and over an extended period of time.
Second if the competition from moneylenders. It would seem that there is lot of potential for growth of gold loan NBFCs due to defection of customers from moneylenders to gold loan NBFCs. But this hasn’t happened to any major extent over the past few years given that the growth of gold loan NBFCs has been lackluster. This could be because of couple of reasons – one, moneylenders are offering a superior product or second, that moneylenders are widely dispersed and it is not feasible for gold loan NBFCs to open branches in all of these areas. I’m inclined to the second reason as both Manappuram and Muthoot have not opened any branches over the last 6 years since FY13. However, this could change in an increasing gold price scenario. Let us see how.
Price of gold
Let us take a look at the AUM growth of Manappuram and Muthoot over the past few years.
- During FY2008-12, gold prices increased at a CAGR of 17%. During the same period, Manappuram’s and Muthoot’s AUM increased from 565cr and 2179cr to 11600cr and 24400cr at a CAGR of 113% and 83% respectively.
- During FY2012-14, gold prices corrected at a CAGR of 13%. During this period of decreasing gold prices, Manappuram and Muthoots AUM decreased at a CAGR of 16% and 6% respectively.
- During FY2012-Dec 2018, gold prices have stagnated. During this period of stable gold prices, the AUM of Manappuram and Muthoot increased at a CAGR of 9% and 8% respectively.
As we can observe from this data, even during periods when gold price declines, the AUM declines commensurately. During the periods when gold price stagnated, the AUM continues to grow at high single digit rates. And I should add that this period of stagnation also included demonetization which slowed down the growth considerably.
In the event of a rising gold price environment, these companies are like a spring which is compressed. Because, gold is a commodity unlike other commodities. Its demand increases as its price goes up. At the same time, the existing stock of gold becomes more valuable. Hence, there is a disproportionate increase in demand for gold loan as the value of the total stock of gold goes up. In this case, it may become profitable for gold loan NBFCs to open more branches as the economies of scale kick in. This would accelerate the movement from unorganized to organized sector.
Based on the evidence, it seems to me that these are solid
franchises which provide a valuable product to their customers. They are also
providing a valuable service by helping to monetize the existing stock of gold
in the country. Add to this the fact that they have a long runway of growth
ahead of them, which is hidden from view due to recent experience of
languishing gold price. But they do have a valuable niche and it would be very
difficult for anyone to dislodge them. As I had mentioned in the previous
article, it is a cockroach like business, which is very hardy and difficult to
 The RoA is from standalone financials for the core gold loan business only