The underlying principle of gold loan goes like this. Person interested to take the loan (borrower) approaches the agency who gives loan (lender). The borrower pledges the gold for a loan of equivalent value with an agreement of paying principal and interest within a stipulated time. As soon as the borrower repays the loan fully, the lender returns the gold back to the borrower. In case of default, the lender has the right to auction the gold to recover the loan amount. The business is attractive due to many reasons. At the current economic scenario where the inflation is very high, gold is a perfect hedge. As inflation rises, value of money depletes, however price of gold always remains intact as demand for the yellow metal is very high in India. Especially, in rural areas where there is not much existence of banks, needy people can approach such lenders and take loan against their gold ornaments. Let's analyze the business opportunity with Porter's five forces model.
The bargaining power of the lenders in the business is high as borrowers falls into the category of people who lacks complete knowledge of valuing the gold that they own. Also these borrowers approach them to meet some kind of urgency either to meet emergency funds requirement for their business or to meet personal demand. Thus in a place where there are really a few number of lenders exists, they can enjoy good margin on the business. Moreover some of the borrowers are ineligible for a loan from bank due to their financial status. The lender values the gold with 80-90% of their market price. The interest rate of these loans is also very high. The prevailing interest rate of gold loans currently ranges from 20-24%. During the period from 2008-2012, there has been a continuous rally of gold prices, which also makes the business attractive for the lenders. The lender also need not have to run after the borrower for the repayment of loan as they already have Gold as deposits. Thus it is always the borrower who has to keep in mind about repayments in a scenario where the prices are always upward moving.
For borrowers, the bargaining power is medium to low, as rules for valuing the gold remains more or less same and there may not be too many people who might give a very good price. They also lack the knowledge on the purity of the gold they own.
There is a huge supply of house hold gold. As per a study there is a potential of mobilizing 15,000 tonnes of house hold gold through the gold loan business. Also in small cities it is a very easy way of financing emergency house hold requirements.
The threat of substitutes is low to medium as borrowers have the option of approaching banks or other persons who may offer a loan. However, many borrowers might have already explored these options before applying seeking a gold loan.
The competitive rivalry in the business is low due to less existence of too many players. There are many regulations which also create lot of entry barriers which deters too many players from entering the business. Due to a history of chit funds Reserve Bank of India has formulated many norms which ban firms to accept money from general public. Moreover it is a must to register before starting such a business. Otherwise the whole business will be considered as illegal and the lenders may be put behind the bars. There is also a need to maintain a safe keep to store the ornaments or jewelries collected from various people as these may be stolen is not kept safely. The climatic condition of the city in which the business is operated is also very important to ensure that ornaments are properly maintained and protected.
Hope I could give you an overview of the business. As you have mentioned, starting with a very low capital may make the business unviable as the business itself requires capital to be disbursed as loan. Moreover it will take a few months and even year to earn handsome margin. The margins come in small installments and over a period of time. You have to be sure about the purity of the gold you take as deposit. The integrity of the depositors has to be carefully evaluated as there may be cases where gold is stolen and kept as deposit for loan. Moreover you have to take very good care of the ornaments being deposited against loan.
Tulika Devi Nath