Which Factors Impact the Gold Loan Interest Rates in India?

Which Factors Impact the Gold Loan Interest Rates in India?

When you take a loan against gold, the amount borrowed is the principal amount. The lending institution also applies an interest rate on the principal amount. Thus, a rate of interest on the loan is the total cost of borrowing, as it as additional cost you have to bear over the principal amount. Since a gold loan is secured (collateral loan) in nature, the interest rate applied on it is lower than that on an unsecured loan.

Interest rates on secured and unsecured loans are impacted by a country’s exchange rate, spare capacity, commodity pricing, and employment. The Bank Rate and Repo Rate also influence a loan’s rate of interest. Social-economic factors of a country influence its Repo Rate. Increase in rate of interest in turn discourages people from borrowing money.

Those who are already using credit facilities on a variable rate, in this scenario, are left with lower disposable income as they have to pay a higher interest cost. So exactly which factors affect the gold loan interest rates by banks and NBFCs? Here is all you need to know about this subject.

Effect of Bank Rate and Repo Rate on Gold Loan Rates

Below-given is information on the effect of Bank Rate and Repo Rate on a gold loan interest rate.

  • Bank Rate: The Reserve Bank of India (RBI) provides funds to commercial banks at a Bank Rate. The loan is collateral-free with tenure between 90 days and a year. To earn a profit, the commercial banks then lend to customers at a higher interest rate than the Bank Rate. This is done by banks to repay RBI, yet keep some funds handy for themselves. So naturally, if RBI increases the Bank Rate, the interest rate on a loan against gold will also increase.
  • Repo Rate: It is known as the repurchase rate, wherein commercial banks take a loan from the RBI to hedge the gap between fund demand from customers and the fund amount banks need to accelerate the cash supply. This allows RBI to facilitate liquidity of cash in the market.

These secured loans are in form of bonds with a lending period of 2 days to 3 months. The commercial banks then repurchase the securities. RBI can increase Repo Rate when it wishes to make it more expensive for the financial institutions to borrow. Thus, an increase in Repo Rate will also cause an increase in the borrowing rate for a loan against gold.

Increase in Gold Rate and its Correlation with Demand and Supply of the Loan

Below-mentioned is the impact of gold loan rate increase on demand and supply for loans against gold.

  • If the gold price increases, many may choose to sell their gold assets and invest the returns in other forms of investments.
  • With increase in rate, the income power of the people also takes a hit. People cautiously spend money, yet there is always a financial strain.
  • High interest rates may lead to a fall in the aggregate demand for gold loans, and encourage people to rather save money than take out new loans.
  • Increase in gold loan interest deters people from borrowing against gold jewellery and bank-purchased gold coins. People may look for other forms of credit borrowing, which come with a lower rate of interest.
  • Eventually due to increased rates and decline of gold loan demand, the rate normalizes to attract borrowers.

Which Factors Influence Gold Loan Interest Rates?

A loan against gold’s interest rate gets affected by the following factors:

  • Income Power: Interest rate on loans increases if the general wage rate of people also increases, and vice-versa. This is why farmers always get subsidies on gold loan rates, because agricultural produce is susceptible to supply of equipment, materials, weather conditions, and a lot more. Similarly, women with a start-up firm can also get discounted rate offers.
  • Inflation: Both inflation and deflation have an effect on loan interest rates. With increase in inflation, the purchase power of domestic currency reduces, and so does the rate of interest.
  • Growth of Economy: If a country’s economy is stable and performing well, then the interest rates may increase with increase in the demand for credit.
  • Type of Loan: Compared to gold loans, interest rates on unsecured loans are higher. As banks assess the risk of lending before finalizing the rate, secured loans always carry an advantage of a lower rate. Thus, even when the economy of a country deteriorates, gold loans will remain as one of the cheapest forms of borrowing.
  • Demand and Supply: Interest rate on a loan against gold increases if the demand for the loan increases. A fall in rates is usually due to higher supply of the loan. Thus, a higher supply of loan is beneficial for borrowers. A rise in loan supply is seen when people choose to open more number of bank accounts, providing surplus funds to banks for lending purpose.

At the same time, if borrowers do not repay the loans, the availability of surplus funds with banks decrease, causing interest rates to shoot up.

  • Safeguard against Possible Changes: Banks safeguard themselves from volatile market conditions, by increasing rate of interest on gold loans. The change expected can be because of a crucial reform in the government policies, change of the government, etc. This is why rates usually increase during the Lok Sabha elections in India.

In Conclusion

Thus, an increase and decrease gold loan interest rates can be caused by changes in Bank Rate, Repo Rate, policies of banks and the Reserve Bank of India, condition of domestic economy, and many other factors. The rates are adjusted sometimes to create a cash flow or reduce the same in the market. So, when faced with a drop or rise in gold loan rates in India, you will be in a better position to understand the reason behind the same, if you go through the above-given information in detail.

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