Investors would deposit gold with the bank and obtain receipts or certificates. The bank would use the gold to make loans. The bank would also be able to pay interest on the gold deposit, depending on the interest it earns on the gold loan. But there are complications in this model.
First, gold carries price risk. When someone makes a gold deposit for say 7 years, he hopes to get back the same amount of gold when it matures. If the price of gold has moved up in that time, the bank runs the risk of having to return something of higher value than deposited. This is more complicated than taking `1,000 as deposit and returning the amount on maturity.
Second, gold is also not fungible like cash, which means not everyone who deposits gold is fine with it being melted and sold away, nor is everyone, except jewellers, comfortable borrowing and returning gold. A gold bank will have to do more than mere intermediation on gold, and take risks on its balance sheet. It will have to provide a bridge between gold and cash on an on going basis, on both the borrowing and lending side. A bank offering gold deposits or bonds will have to continuously convert gold to cash and back, and do this at a profit. This means capital requirements, hedging costs, and asset-liability mismatches.
There are two successful products that partially monetised gold in recent times. The first is the gold loan of NBFCs. This product enabled households to use idle gold as collateral and release money as needed. But to the NBFC that made the loan, the asset is still idle on its books and subject to price risks. The second is the gold advance payment schemes of jewellers where customers make instalment payment for future purchase of gold. The advances fund the gold jeweller and act as a loan. The success of these schemes hinges on the understanding of the household's behaviour. They do not like to borrow to buy gold, but save for buying in the future; and they will take loans against what they hold, in case of need, but like to get their gold back when they repay.
The gold bond and gold deposit that the government has proposed in the Budget, will have to be managed by an entity similar to the Bullion Corporation of India. An entity offering the gold deposit or bond, it will have to accept gold jewellery, coins and bars offered by the household, value and assay the gold, and convert it to into bars. It would have to offer two-way quotes to buy and sell gold, offer storage and insurance facilities, and be ready to swap, trade and hedge its gold stocks for other financial instruments. It will be a profitable business only if it is able to do all of this. With a well-capitalised balance sheet, this is not a tough act to pull off.
Banks may not be interested in the proposition. If banks are asked to issue these products, households will dislike the paperwork, disclosures, protest the conversion of jewellery into gold bars, and seek liquidity rather than locked-in products. If the government allows banks to keep a part of their statutory reserves in gold, rather than in government securities, a market might take off.
Banks will be eager buyers keen to make most of the asset they are compelled to hold, and push for more transparency in the gold markets. The trick is in acknowledging the appetite of the household savings for gold, rather than seeking to curb it somehow. Let's wait to see what the guidelines for this product look like. We can then see if it would be a game changer.
1.ICICI Prudential Tax Plan
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10.BNP Paribas Long Term Equity Fund
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