Pawning Loans
Benefits to Sri Lanka banks from pawning guarantee temporary: S&P July 17, 2014 (LBO) - Benefits from a state guarantee for gold-backed loans (pawning) will be temporary, a report by Standard & Poor's, a rating agency said."The credit guarantee for pawning loans will provide only brief respite to Sri Lanka's banking industry, which is still struggling to overcome the effects of declining gold prices," said Standard & Poor's credit analyst Deepali Seth-Chhabria said in a statement.
"The banking industry will remain vulnerable to the volatility in gold prices, given that pawning loans form a significant part of banks' loan books, unless essential structural and regulatory changes are implemented."
The guarantee encourages banks to lend up to 85 percent of the value of gold instead of around 60 percent.
Banks that loaned money when gold prices were around 1,700 US dollars an ounce, were hit by defaults when prices fell to 1200 to 1,300 dollars an ounce.
Banks then cut back on total pawning loans in 2013 and so far in the first quarter of 2014.
Standard & Poor's expects the overall volume of pawning loans to increase with new loans.
But a cap on interest rates could lower margins along with a premium that has to be paid to the Central Bank.The full statement is reproduced below:-
Sri Lanka's Loan Guarantee Will Benefit Its Banks, But Only For A While
SINGAPORE (Standard & Poor's) July 15, 2014--Sri Lanka's decision to guarantee pawning (gold-backed) loans could be a blessing for the country's troubled banks. But the reprieve is unlikely to last too long. That's according to a report titled "Sri Lanka's Pawning Loan Guarantee Could Temporarily Cushion Banks' Flagging Performance," that Standard & Poor's Ratings Services published today.
"The credit guarantee for pawning loans will provide only brief respite to Sri Lanka's banking industry, which is still struggling to overcome the effects of declining gold prices," said Standard & Poor's credit analyst Deepali Seth-Chhabria. "The banking industry will remain vulnerable to the volatility in gold prices, given that pawning loans form a significant part of banks' loan books, unless essential structural and regulatory changes are implemented."
The Sri Lankan central bank's credit guarantee scheme for pawning loans aims to increase funding to sectors that are important for economic development. Growth in funds to such sectors slowed last year as banks cut back on pawning loans following an increase in nonperforming loans (NPLs) in the pawning segment as gold prices declined. The scheme encourages banks to once again divert funds toward pawning--a segment that is already vulnerable to gold price volatility--and that too at higher loan-to-value ratios. Banks scaled back in both these areas last year as gold prices fell and NPLs rose.
"Banks may put off tightening their risk management systems to ensure limited losses in the pawning segment because the guarantee would provide a cushion against the losses," said Ms. Seth-Chhabria. "We believe that while relatively relaxed underwriting standards and regulations in the pawning segment resulted in strong loan growth in 2009-2012, they also contributed to the higher defaults thereafter."
Standard & Poor's expects the overall volume of pawning loans to increase as banks offer incremental credit under this scheme and the ones that had curbed lending in 2013 begin issuing new pawning loans. Nevertheless, the scheme could lower banks' margins on pawning loans because of a cap on the interest rate on loans offered under the scheme. In addition, operating costs for the pawning segment will likely increase because banks will have to pay the central bank a premium under the guarantee. But the reduction in credit costs should offset this increase.
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