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RBI ban on gold lending to dampen growth and profitability

* IIFL Finance (IIFL) hosted a conference call on 5th Mar’24 to clarify the issues raised by the RBI regarding the company’s gold loan business (RBI press release), the corrective actions taken by the management, and the way forward for the company. IIFL also shared the contribution of the gold loan business to its profitability, the fixed cost of gold loan branches and the sequence of events that culminated in this RBI ban.

* It is difficult to predict how long it could take to work with the regulator and get this ban reviewed and revoked. However, in light of some recent episodes where the RBI banned certain activities/products of financial institutions, our base case assumes that it could take around six months to get the RBI to conduct a special audit and subsequently rectify the observations to the satisfaction of the RBI. After incorporating the impact of this ban on IIFL’s gold loan growth in our estimates, we cut our FY24/FY25/FY26 EPS estimates by 2%/14%/15%.

* Beyond the immediate impact on incremental gold loans, IIFL will also have to work with its existing customers and co-lending partners to prevent any damage to its gold loan brand and trust that it has built over last many years. It will also have to make efforts to retain existing customers and employees.

* The actual financial impact will depend on the duration for which this ban remains in force and we will continue to closely monitor the developments over the next few quarters. While there could be near-term price volatility in the stock, we have maintained our BUY rating with our SOTP-based TP of INR560 (based on revised target multiples on each of its standalone, HFC and MFI businesses, in light of the recent observations made by the RBI).

* Key risks: 1) sharper run-down in the gold loan portfolio and employee attrition if the ban remains in force for longer, and 2) reputational damage which might necessitate renewed investments in building trust in its brand.

Issues identified by RBI and corrective actions proposed by IIF

* Observation 1: Serious deviations in gold appraisal and certification of purity and net weight of gold at the time of sanctioning gold loans and at the time of auction upon default; breaches in loan-to-value (LTV) ratio

* Issue 1: Appraisal of gold jewelry is a manual and subjective process (industry-wide). There were deviations observed by IIFL’s internal audit team when they appraised the gold at the time of auctions. IIFL disbursed ~1.89m gold loans in FY23, of which ~82,000 went for auctions and deviation was identified in ~55,000 cases from the auctioned loan pool. The RBI for its inspection has just taken a sample of the auctioned gold loan accounts.

* Corrective Action 1: IIFL has taken corrective actions to ensure that these deviations are minimal. Most of its co-lending partners open each and every gold loan packet and make their own assessment of gold purity and weight. Going forward, it will ensure that the quality assessment of gold jewelry will be more stringent.

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