Financial Services
Fighting COVID: no silver bullet, but gold will help
09 Jun 2020
This is wartime, the enemy is COVID-19, no less, and hopefully, the human race is on the same side. The enemy has made deep inroads in our territory – it has crippled the economy, threatened livelihoods and pushed businesses to the brink. The Government of India has announced a package of Rs 20 trillion and really needs the resources to be able to spend the committed monies. Citizens have donated money, gold and silver during wartime to help their nation fight the enemy; its no different this time. Thanks to our penchant for stowing away gold and jewelry in our lockers, we literally have tons of the stuff lying around unused; the World Gold Council estimated in 2017 that Indian households hold 23,000 tons of gold & jewelry. The value of this gold is nearly USD 1 trn (~ Rs 75 lac cr); over 40% of the market capitalization of the Indian stock markets. 
Its time then, for us to put the yellow metal lying in our lockers to work. With advances in finance and technology, we don’t really have to resort to donation and collection drives similar to the ones seen in, say, World War II. This pandemic and the economic calamity it has created provides an opportunity for both households and the government to use gold stock in the country to revive the economy.  The efficiency of monetizing an asset is directly proportional to the degree of tradability of ownership which, in turn, can be significantly increased by digitizing ownership and custody records. Examples in stock, bond and commodity markets are ample proof of this concept. Seamless borrowing and lending of securities, as well as loans against securities, developed when the ownership data was digitized. The same is true with commodities, where, in addition to ownership, digitization of custody or storage data has greatly improving futures trading. Why could we not do the same for gold ownership?
The good news is that gold loan companies, banks and NBFCs who give loans against gold already do some parts of this process, except that the data and its usage is in closed user groups, which doesn’t enable the ecosystem to enjoy positive externalities that a standardized and universally accessible database could possibly generate. We propose that scheme to create a dematerialized form of gold be launched, the key features of which could be:
  1. Permit established and credible entities such as banks, gold loan companies, online platforms for purchasing or lending against gold, etc. to leverage their distribution and customer base to collect gold from individuals and households.
  2. Allow impaneled valuers (including players that already serve banks and NBFCs engaged in the gold loan business) to provide quantity and quality certificates, for e.g. Customer id 111 deposited 4 bangles with a weight of 10 grams each made of 22-carat gold. This will allow lenders and other interested players to attribute a value to this based on which financial products can be designed.  
  3. License players to store the gold and jewelry – these could be vaults of players already engaged in this business or authorized branches of banks or NBFCs. 
  4. The quantity and quality of gold deposited by each customer be credited to a ‘Demat’ account and we could possibly leverage the NSDL and CDSL infrastructure for the same. The gold and jewelry lying to the credit of the Demat account are always backed 100% by physical gold in approved storage facilities. Like any other security lying to the credit of a Demat account, the gold can be transferred or pledged to facilitate seamless transactions. 
  5. Lenders can simply mark a lien on this Demat account to lend against the value of the collateral. That would open up the lending against the gold business to a wider variety of players, not just entities who have mastered the act of valuation and storage.
  6. The gold stock can be ‘rematerialized’, which means that the depositors can take out the gold (which does not have a lien on it by a lender) from the storage with the appropriate entry in the Demat account. This facility will help deal with the emotional and social aspects of holding gold.
  7. In order to kick-start the process of unlocking the value of the gold lying with households, the Government could give an incentive of, say 0.25% of the AuM to the authorized distribution points (banks, NBFCs, etc.) for the first two years of the scheme. 
Disintermediating the loan against the gold value chain this way will allow for deep expertise to be built in each element – customer acquisition and servicing, valuation, storage, lending at most competitive rates, or even providing risk management solutions such as hedging gold price on an exchange. The operating cost of gold loan players can be significantly reduced as customers repeatedly pledge their gold and then release it in a few months only to start all over again. 
This is not really a new idea and has been tried before, including through the recent Sovereign Gold Bond (SGB) and Gold Monetization (GMS) schemes. What is different this time? 
  1. Unlike in the SGB scheme, no additional cash outlay is involved. This scheme is aimed at helping households benefit from the gold already with them, and hence doesn’t compete for a share of wallet with bank deposits, mutual fund investments of life insurance policies.
  2. The appeal of the GMS scheme for customers was limited since the subsequent parts of the process were not well defined and limited product offerings were available. Using the Demat account will address that issue to a significant extent.  
  3. The SGB and GMS schemes were launched when banks had their hands' full pushing investment, insurance, retail loan and credit card products to their customers. These gold schemes were simply not lucrative enough. COVID-19 has effectively dried up several avenues of earning fee income and lending, and banks will probably be very keen to add to their product basket in these times of stress. 
Once we create a pool of ‘digital gold’, there are enough and more financial products available for market participants and the Government to put it to work. That is probably the subject matter of another article, but one example could be to allow banks and NBFC’s to lend for longer tenors (3-5 years) at competitive rates, another could be to create a market for lending and borrowing of gold, and so on.   
While we do not hold out the above ideas as a silver bullet to win the COVID war, having a bit of gold never harms.

Authored by (at the time of writing): 
Shishir Mankad, Leader, Financial Services Practice 
Harsh Vardhan, Executive-in-Residence, Centre for Financial Studies (CFS), SP Jain Institute of Management & Research 

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