Manappuram and Muthoot, gold loan providers, soar while IIFL Finance stocks plummet due to an RBI crack.

Following the RBI’s limitations on peer IIFL Finance, shares of gold financiers Manappuram Finance Ltd. and Muthoot Finance Ltd. increased by as much as 8% and 14%, respectively.

On March 5, shares of IIFL Finance dropped to a 20% lower circuit.

The RBI placed limits on rival IIFL Finance due to significant supervisory concerns in its gold loan portfolio, which caused shares of Manappuram Finance Ltd and Muthoot Finance Ltd to rise as much as 14% on March 5.

In response to the central bank’s action, the IIFL Finance shares fell 20% on March 5. Conversely, Manappuram Finance posted the most intraday increase in a single day since September 2020. On the NSE, the stock, however, pared gains and was trading 4% higher at Rs 192.

Muthoot’s stock increased for the fifth straight day, reaching its highest level since June 2020. Muthoot Finance shares were up 4% from the previous closing at Rs 1,398.05 at 10:58 a.m.

When loans were approved and when the gold was put up for auction after default, the central bank noticed significant discrepancies in the assaying and certification of the purity and net weight of the gold by IIFL Finance.

In a conference call, IIFL Finance discussed the effects of the RBI limits and gave investors the assurance that there won’t be a big decline in short-term profitability. It claimed that no governance or KYC-AML concerns were mentioned in the RBI report.

The company emphasized that there is no prohibition on gold auctions for recovery purposes and confirmed that their recovery procedure is unaffected. They also stated that they planned to provide the RBI with a compliance report as soon as possible.

According to Motilal Oswal, this is a significant setback for IIFL because a significant amount of the company’s co-lending was in the gold loan area, and gold loans make up 32% of its AUM mix. Given that these are errors in procedure, the business and the regulator can collaborate to address the observations it made on the gold loan portfolio.

“Given that there is little clarity on the duration for which this ban could remain in effect, it is difficult to quantify the impact of this ban on IIFL’s AUM growth and profitability,” the brokerage stated.

With a target price of Rs 765 per share, Jefferies has kept its ‘buy’ call on IIFL Finance. The brokerage stated that the Reserve Bank of India (RBI) limits could have a negative impact on earnings, especially when it comes to the unwinding of gold loans, which account for 32% of the company’s AUM. These restrictions are subject to review following a special audit and rectification process.

The restrictions may raise the cost of money and result in a drop in co-lending revenue. Jefferies predicts that IIFL Finance’s EPS might be affected by more than 25–30 percent if the prohibition on gold lending lasts for nine months.

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Frequently Asked Questions (FAQS)

1. What triggered the RBI’s restrictions on IIFL Finance?
   • The RBI’s restrictions were triggered by serious deviations observed in assaying and certifying the purity and net weight of gold by IIFL Finance at the time of sanctioning loans and at the time of auction upon default.
2. How did Manappuram Finance and Muthoot Finance’s shares respond to the news?
   • Following the announcement of RBI’s restrictions on IIFL Finance, shares of Manappuram Finance Ltd. and Muthoot Finance Ltd. experienced significant gains, with Manappuram Finance seeing up to 8% and Muthoot Finance up to 14% increases.
3. What are the specific concerns raised by the RBI regarding IIFL’s gold loan portfolio?
   • The RBI was concerned about serious deviations in the procedures for assaying and certifying the purity and net weight of gold involved in IIFL Finance’s gold loan operations, both at the time of loan sanction and during auction processes upon default.
4. How significant are gold loans to IIFL Finance’s overall business?
   • Gold loans constitute 32 percent of IIFL Finance’s Assets Under Management (AUM) mix, indicating a significant portion of its business is reliant on gold lending activities.
5. What has been IIFL Finance’s response to the RBI’s restrictions?
   • IIFL Finance addressed the RBI’s restrictions in a conference call, reassuring investors that the near-term profitability is not expected to suffer significantly. They also stated that the RBI’s report did not point out any governance or KYC-AML issues, and highlighted that their recovery process remains unaffected with no embargo on auctioning gold for recovery purposes.
6. How might the RBI’s actions affect IIFL Finance’s near-term profitability?
   • Despite IIFL’s reassurance, the RBI’s actions could potentially impact the company’s near-term profitability, mainly through the limitations on its gold loan operations which are a substantial part of its business.
7. What are the potential implications for IIFL’s co-lending activities?
   • The restrictions could lead to a decline in co-lending income for IIFL Finance, as a significant proportion of its co-lending was done in the gold loan segment.
8. How long could the RBI’s restrictions on IIFL Finance last?
   • The duration of the RBI’s restrictions on IIFL Finance is uncertain, with little clarity provided in the report. The restrictions are subject to review after a special audit and rectification process.
9. What impact could the RBI’s decision have on the broader gold loan market?
   • The RBI’s decision could have a varied impact on the gold loan market, potentially leading to stricter regulatory oversight for gold loan operations across the sector and affecting the market dynamics among competitors.
10. What do investment experts think about the situation?
    • Investment experts like Motilal Oswal view the situation as a major negative setback for IIFL, due to the significant role of gold loans in its business. However, Jefferies has maintained a ‘buy’ call on IIFL Finance, suggesting that the impact of the restrictions, while potentially significant, could be mitigated over time with proper rectification measures.