Unravelling the Constraints

FACILITATING POLICY CHANGE

Unravelling the Constraints

April 2017

Nirupama Soundararajan Arindam Goswami

GOLD MONETISATIONUnravelling the Constraints

April 2017

Authors

Nirupama Soundararajan and Arindam Goswami


For further information about this report, please contact:

Nirupama SoundararajanSenior [email protected]

Arindam GoswamiAssociate [email protected]

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India’s relationship with gold dates back to several centuries. Gold is considered to be an integral part

of the society that is purchased, gifted and even donated at childbirth, wedding, auspiciousoccasion,

and even on the occasion of a good harvest. Traditionally, goldis handed down by the elders to the

next generation, a more common practice among the women folks in the family. In few words, gold

is entwined with the Indian way of life. The tradition of accumulating gold over generations has led

almost all Indian familiesin holding some amount of gold as house-held savings. Studies suggest

that an estimated 23000 – 24000 tonnes of gold is currently being held by the Indian households.

Even so, the demand for gold in India is perpetually increasing.

In November 2015, the Hon’ble Prime Minister of India, launched the gold monetisation drive which consisted of three

important schemes namely the Gold Monetisation Scheme, the Sovereign Gold Bond and the India Gold Coin. The main

objectives of this troika are to recycle the enormous house-held gold reserve, reduce the dependency on import and deviate

the demand for investment in physical gold to that in gold backed financial products. Yet, with “gold monetisation” becoming

the buzzword, the notion was cursory in nature mainly due to the haphazard implementation of the various schemes.In fact,

apart from Sovereign Gold Bond, which had a limited success in its initial run, the remaining two schemes failed to garner

much attention among prospective takers. While the various stakeholders of the schemes pointed fingers at each other for

its failure, the main reason can be largely attributed to the two reasons, first, the lack of trust coordination between the

stakeholders, and two, the poor participation of banks in these schemes.

The authors of this study at Pahle India Foundation have been working on gold for over five years. Their in depth knowledge

on the subject and their various interactions with stakeholders was the reason for undertaking this study. With stakeholders

pointing fingers at each other for the poor performance of the schemes, we decided to explore and identify the binding

constraints for gold monetisation and try to find solutions to make it work. This was done through a detailed primary survey

involving 42 banks, 14 refineries, 150 assaying centres and 500 jewellers. Apart from this, detailed one on one interview

were conducted with selected stakeholders and policy makers. Further, three roundtables, one each in Mumbai, Bengaluru

and New Delhi, were held under Chatham House Rules, to further discuss and find solutions to the current issues.

The study revealed a gamut of findings broadly around how to better integrate the various stakeholders of the three

schemes, on the kind offrameworks needed to create a sturdy gold ecosystem, and the necessary regulatory mechanism that

will help in integrating gold more holistically with the real economy.

We hope that the various recommendation which emerged through the study will help in bolstering the three schemes and

will further help in achieving the desired result of the gold monetisation drive.

Ram Gopal Agarwala

Foreword

Gold Monetisation Unravelling the Constraints

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This report is the result of extensive field work and numerous interviews. Without the help of many organisations and people, this report would not have been possible.

The authors would like to thank Subrata Bandyopadhyay, Rajendra Prasad, Ankur Tyagi and their team at BRIEF for implementing the primary surveys and in collating the results.

The authors would also like to thank the various interviewees and survey participants for meeting with us and sharing their experiences on Gold Monetisation Scheme (GMS), Gold Metal Loan (GML), the role of banks in monetisation of gold, and other crucial aspects on creating an ideal ecosystem for gold in India. We had excellent participation during our discussions at the roundtables held in New Delhi, Mumbai and Bangalore.

Last but not least, we would like to thank Tara Nair for copy editing the report, Anil Kumar from Pahle India Foundation for helping us with our meetings, organising our roundtables and formatting the report and Naveen Jaiswal and his team at Genesis Printers for designing, layout and printing the final report.

Acknowledgement

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Abbreviation ............................................................................................................................. 10

Executive Summary .................................................................................................................. 13

1. Overview .............................................................................................................................. 19

1.1 Background 21

1.2 Monetisation of Gold in India 21

1.2.1 Gold Monetisation Scheme (GMS) 21

1.2.2 Sovereign Gold Bond (SGB) 21

1.2.3 India Gold Coin (IGC) 23

1.3 Identifying the Binding Constraints 24

1.4 Objective and Methodology of Study 24

2. Gold Metal Loan (GML) ......................................................................................................... 272.1 Procurement of Gold 29

2.2 History of GML 32

2.3 Working of GML 33

2.4 Banks and GML 35

2.5 Non-Performing Assets Arising from GML 36

2.6 Jewellers and GML 40

2.7 Dwindling Popularity of GML 42

3. Gold Monetisation Scheme (GMS) ........................................................................................ 433.1 Evolution of GMS 45

3.2 The Process 47

3.3 The Problems 47

3.4 The Role of Jewellers in GMS 49

3.5 Making GMS Work 49

Contents


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4. Gold Exchange and Gold Regulations .................................................................................. 534.1 Gold Exchanges around the World 55

4.1.1 Case of Turkey 55

4.1.2 Case of Dubai 55

4.1.3 Case of China 55

4.1.4 Case of Singapore 56

4.2 Why India Needs a Gold Exchange? 56

4.3 Options for India 57

4.3.1 Gold Spot Market or Spot Platform 57

4.3.2 Gold Derivatives Market 58

5. Bullion Banking in India ....................................................................................................... 61

6. Gold Vaulting in India ........................................................................................................... 67

7. Recommendations ................................................................................................................ 71

7.1 Regulatory Guidelines 73

7.2 Revamped – Gold Deposit Schemes (R-GDS) 73

7.3 Gold Metal Loan 73

7.4 Trade on Exchange 73

7.5 New Gold Products 74

7.6 Gold Swaps and Inter Bank Lending 74

7.7 Marketing Strategies 74

Contents

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List of Tables 3.1 Basic differences between GDS and R-GDS 45

4.1 Comparative cost of hedging on exchanges 59

2.1 Average quantity of gold bought by jewellers 29

2.2 Sources of procurement of gold by jewellers 30

2.3 Gold products offered by banks 31

2.4 Reasons for not importing gold 31

2.5 Total volume of gold imported by banks 32

2.6 Diagrammatic representation of GML 34

2.7 Total number of jewellers banks dealt with 35

2.8 GML in peak season vis-á-vis non-peak season 36

2.9 NPAs arising from GML 36

2.10 NPA arising out of GML in banks undertaking GDS vis-á-vis non-GDS 37

2.11 Likely utilisation of gold collected as part of GMS 38

2.12 Popularity of GML among banks 38

2.13 Banks’ perspective over increase in popularity of GML 39

2.14 Intensity of increase in GML (for banks responding in positive in 2.13) 39

2.15 Channels used by jewellers to source gold 40

2.16 Reasons for not preferring GML over other sources of procurement 41

2.17 Periodical sourcing of gold in peak season vis-á-vis sources for procurement 41

2.18 Periodical sourcing of gold in normal season vis-á-vis sources for procurement 42

3.1 Advantages of GMS 46

3.2 Deterrents to success of GMS 46

3.3 Awareness about GMS 48

3.4 Impact of GMS on Business 49

3.5 Reasons for never entering into interbank swaps 50

3.6 Perceptions 51

List of Figures


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List of Abbreviations

APMC Agricultural Produce Market Committee

BIS Bureau of Indian Standards

BSE Bombay Stock Exchange

CAD Current Account Deficit

CME Commodity Mercantile Exchange (United States)

CPTC Collection and Purity Testing Centre

CTT Commodity Transaction Tax

DCA Department of Consumer Affairs (under Ministry of Consumer Affairs,

Food, and Public Distribution)

DCCC Dubai Commodities Clearing Corporation

DGCX Dubai Gold & Commodities Exchange

DGFT Directorate General of Foreign Trade

EEE Exempt-Exempt-Exempt

ELSS Equity Linked Savings Scheme

ETF Exchange Traded Funds

FAQ Frequently Asked Questions

FI Financial Institution

FY Financial Year

GML Gold Metal Loan

GMS Gold Monetisation Scheme

GoI Government of India

IBJA Indian Bullion Jewellers Association

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ICBC Industrial and Commercial Bank of China

IGC India Gold Coin

IGE Istanbul Gold Exchange

INR Indian Rupee

LBMA London Bullion Market Association

LPPM London Platinum and Palladium Market

LTCG Long Term Capital Gains

MCX Multi Commodity Exchange of India Limited

MMTC Metals and Minerals Trading Corporation of India

MoC Ministry of Commerce

MoF Ministry of Finance

NBFC Non-Banking Financial Institution

NPA Non-Performing Assets

NRI Non-Resident Indian

NSE National Stock Exchange

NWR Negotiable Warehouse Receipts

OTC Over-the-Counter

PoS Points of Sale

PSB Public Sector Bank

PSL Priority Sector Lending

PSU Public Sector Unit

RBI Reserve Bank of India


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R-GDS Revamped Gold Deposit Scheme

SEBI Securities Exchange Board of India

SGB Sovereign Gold Bond

SHCIL Stock Holding Corporation of India Limited

SB/LC Stand-By Letter of Credit

SLR Statutory Liquidity Ratio

SPMCIL Security Printing & Minting Corporation of India Limited

SGPMX Singapore Precious Metals Exchange

STH Star Trading House

UAE United Arab Emirates

USA United States of America

VAT Value Added Tax

WDRAI Warehouse Development Regulatory Authority of India

XRF X-ray Fluorescence

YTD Year to Date

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Executive Summary

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It was not until around fifteen months ago that the Government of India took cognisance of the fact that the domestic stock of gold (23,000-24,000 tonnes) lying with its households could be monetised. The reason for this late epiphany can be attributed to India’s then escalating current account deficit (CAD) on account of steady increases in gold import. India’s gold mines contribute to less than 0.5 per cent of total gold consumed ever year. In 2015, India mined less than 2 tonnes of gold.

The lack lustre performance of existing gold monetisation schemes, the lack of participation of retail customers, lack of innovative gold backed and gold related investment products and the increasing dependence on gold imports forced the government to re-examine its policy stance, or rather the conspicuous absence of one, on gold. India’s efforts towards monetising gold began with budget announcements made in 2015.In November 2015, the three gold monetisation schemes were launched with the promise that the products would be transparently and easily available.

Many constraints have been highlighted by various stakeholders for the limited success of the monetisation schemes. The objective of this study was to identify the binding constraint for gold monetisation and examine the reasons for its existence and come up with suitable recommendations to remove the constraint so that gold monetisation may gain momentum. Taking a cue from Turkey, where monetisation of gold gained immense momentum when the Turkish banks actively participated in the process, we examined the role of banks in the context of gold monetisation

in India.For this purpose, a detailed primary survey of 42 banks, 14 refineries, 150 assaying centres and 500 jewellers was undertaken to capture the responses of all stakeholders, both up and down the value chain of GMS. Apart from the primary survey, detailed one on one interviews were conducted with several stakeholders. Further, three roundtables, one each in Mumbai, Bengaluru and Delhi, were held under Chatham House Rules, to further discuss the issues that emerged from the survey and to identify possible solutions to them.

Gold Metal LoanWe found the most preferred channel of procurement of gold for jewellers is from the domestic market, followed by the import of gold. Banks typically import gold in anticipation of demand rather than wait for orders to be placed. The average gold imported by banks in the financial year 2014-15 was 639 tonnes and from April 2015 to December 2015 was 414.5 tonnes, as per our survey. The Gold (Metal) Loan or GML, as a source of procurement of gold would be ideal for jewellers. The advantage of GML over outright purchase is that, GML is offered on unpriced gold. Of the 42 banks surveyed, 13 banks are currently offering GML and have stated that they have 1165 jewellers as customers. Furthermore, 172.5 tonnes of gold had been loaned out through GML in the 2014-15 financial year. Survey shows that of the 13 banks undertaking GML, only 5 banks undertook the Gold Deposit Scheme (GDS).

Of the 13 banks offering GML, 46 per cent banks responded that they had no NPAs arising from GML and another 8 per cent between 3.1 to 5 per cent

Executive Summary


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from GML. When compared to non-performing assets (NPAs) arising from other loan products of banks, NPAs from GML was found to be negligible.NPAs arising from GML for those banks undertaking both GML and GDS was higher than those undertaking only GML.This trend can be problematic in the future because if it continues, banks that offer GMS will find it difficult to return the deposited gold, once again making them dependent on imported gold. For banks, lending gold through GML emerged as the most likely way to utilise the gold collected through GMS. Popularity of GML has gone down among jewellers. Jewellers prefer importing on consignment basis, buying from the domestic market or buying back from customersover GML because of high cost of borrowing. The spread between the rates of interest (RoI) offered by overseas suppliers and domestic banks varies anywhere from 1 to 2 per cent. However good quality of gold and convenience and quicker delivery are strong incentives for jewellers to opt for GML. GML does have the potential to grow as a product of interest among jewellers if necessary policy changes are made.

Gold Monetisation SchemeThe GMS is a combination of the revamped GMS (R-GMS) and GML, introduced in November 2015 as a means of attracting above-ground stocks of gold into the financial system. All stakeholders, banks, assaying units, refiners, and jewellers agree that GMS will increase their respective business volumes. The current procedure for GMS can appear to be onerous for the retail investor. The already tedious process of GMS is also riddled with many operational hurdles.The pain point have been the CPTCs. No financial audit of CPTCs is undertaken. Banks, therefore, are uncomfortable about taking any credit exposure that can expose them to

credibility risks. For a more seamless relationship between banks and CPTCs, two suggestions have been made. The first is that CPTCs should provide an initial guarantee equivalent to 30 per cent of the agreed exposure limit, which is usually up to one kilogram of gold. The second was to come up with a suitable mechanism of credit rating for CPTCs, which would automatically entail a financial audit. Most CPTCs, though willing, do not have the financial wherewithal to provide guarantees to several banks.

Jewellers are the missing link in the current GMS chain. Jewellers have the capacity and capability to market GMS and convince their consumers to participate in GMS. Jewellers have been apathetic to becoming CPTCs possessing a fire assay, for two reasons. One, they do not believe that a fire assay is essential to offer a fair valuation to the consumer. Two, as jewellery shops are in residential areas, suitable environmental clearances for housing a fire assay may be difficult to obtain. Jewellers doubling up as CPTCs will certainly help in scalability and for this the need for a fire assay must be re-examined. Furthermore, a consumer may opt for the valuation offered by jewellers for two reasons – one, it would save them the effort of having to find a CPTC and take their valuables to an area that is unfamiliar to them, and two, consumers are more likely to trust their jeweller’s valuation due to a pre-existing relationship.

Another drawback lies in the lack of options available to banks for use of gold collected through GMS.Interbank lending of gold collected through GDS was allowed under GDS and has also been allowed for GMS. However, not many banks have availed of this option as a way of utilising collected gold. The need of the hour is for more sophisticated product offerings such as interbank swaps and

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foreign currency swaps such as dollar swaps. Other enabling provisions that could be to allow NBFCs to also participate in GMS by allowing them to collect gold. The regulator may provide eligibility guidelines for NBFC participation.

Gold Spot Exchange in IndiaCountries such as Turkey, Dubai, and China noticed the upswing in the demand for gold and created the necessary infrastructure to control the supply of gold among Asian countries and dominate the global gold trade. One of the first steps toward this was the setting up of gold exchanges. A formal trading place that facilitates transparent buying and selling of gold is what is necessary in India. Such a platform can help in price discovery, remove price disparities, and establish quality. This will also ensure better integration with financial markets creating a better gold recycling process and creating a robust gold ecosystem.

Notwithstanding the many shortcomings of the mandi or the APMC Act, agricultural commodities atleast have an organised platform on which they can be traded. On the other hand, almost all gold transactions take place in the unorganised market.Despite being one of the largest consumersofgold, India does not have a spot market for gold. The lack of standardisation of gold purity has been a big hurdle that has prevented any organised spot market from developing. The regulatory framework for setting up a gold spot exchange has also not been very clear.

Bullion should not be treated on par with agricultural commodities, or even non-agricultural commodities. Bullion or at least precious metal (gold, silver, platinum and palladium) must be a separate category and one that must be spelt out clearly under the Union List. For the purpose

of gold monetisation, all gold must be viewed as a prospective financial asset and hence must be moved to the Union List. The regulation of gold spot market should be moved under the purview of either the Ministry of Finance (MoF), Ministry of Commerce (MoC), Securities Exchange Board of India (SEBI) or a suitable financial regulator. A draft framework or guidelines for operations, issued by the MoF, may nudge the private sector to set up spot trading exchanges or platforms.

Bullion Banks for IndiaCommercial banks in India play a crucial role in integrating gold with the financial sector. This role is restricted largely to import of gold and a handful of government run schemes.In a country where more than 98 per cent of the gold consumed is met through import, banks, as the most trusted financial entities, would have been expected to play a more dominant role. This is sadly not the case. Bullion banking is a well-established concept among developed economies and has been in existence in both Europe and the Americas for a long time.Most bullion banks are diversified business arms of larger commercial and investment banks specialising in the commodities business, more specifically in precious metals. bullion banks are engaged in the business of precious metals through market trading, clearing, vaulting, distribution through leasing and sale, acting as an agent between lender and borrower, mine financing and hedging, and generating research data on precious metal market among other activities.Globally, almost all bullion banks maintain a membership with the LBMA and its sister concern, the London Platinum and Palladium Market (LPPM).

In India, bullion banking is yet to become an established concept as banks do not consider


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bullion to be their mainstay business.Commercial banks dealing in gold face stiff competition from the unorganised gold jewellery sector, which in turn affects their primary banking business. There are multiple regulators involved in the business of gold.The agony of dealing and co-ordinating with assorted regulators at the same time make most banks averse to participating in the gold business. Despite these predicaments, if a bank does take up the gold business, hedging price risk becomes a dilemma as RBI does not allow banks to participate on domestic commodity exchanges (except for GMS). With RBI’s commitment to issuing differentiated banking licences, it is the perfect opportunity to create a niche banking set up for the specific purpose of dealing in bullion. A bullion bank can be a ‘one-stop’ institution responsible for undertaking lending and borrowing of gold, installing a vaulting mechanism, lending logistical support to gold distribution and helping as a repository of bullion related data and information. Most importantly, introduction of a bullion bank will provide the much needed push to the gold monetisation programme.A bullion bank will also play an important role in the global bullion market. India can have its own bullion bank participating in the global price discovery mechanism, such as the LBMA benchmarking and the Shanghai benchmarking.

Gold Vaults in IndiaWarehousing of gold and precious metals, also known as vaulting, is the mainstay of a robust financial and business bullion ecosystem. The need

for a regulated vaulting mechanism can be gauged by the fact that the leading countries in bullion business today have all developed and maintain a very high standard of vaulting infrastructure.In India, bullion vaulting is still at a nascent stage. Bullion vaults in India are largely unregulated entities. Recently, SEBI has directed the commodity derivatives exchanges trading in bullion to register vaults used by them and adhere to basic vaulting guidelines. However, this surrogate regulatory system extends only up to vaults under exchanges but fails to govern those used by banks, bullion depositing NBFCs, asset management companies and other FIs dealing in bullion. WDRAI is responsible for the development and regulation of the warehousing business, to ensure the negotiability of warehouse receipts and to promote the orderly growth of the warehousing business in the country. Currently, WDRAI regulates only warehouses for storage of agricultural commodities. WDRAI should extend its regulatory outreach to warehouses (vaults) storing gold and other precious metals.

RecommendationsBased on the findings of the survey, the study makes many recommendations around how to involve banks more in the gold monetisation schemes, on what kind of new infrastructure is required to create a more robust gold value chain, and the necessary regulatory frameworks that must be crafted to help integrate gold with the financial sector and the real economy.

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Chapter 1:Overview

Key Points

■ It is in India’s best interest to reduce dependence on imported gold

■ In November 2015, the three gold monetisation schemes were

launched

■ The reach of the SGB can further be enhanced

■ The success of IGC lies in increasing the number of distribution

channels

■ In the case of GMS the lack of bank participation is the binding

constraint

■ The objective of this study was to examine the reasons the constraint

■ Primary survey of 42 banks, 14 refineries, 150 assaying centres and

500 jewellers was undertaken

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1.1 BackgroundIt was not until around fifteen months ago that the Government of India took cognisance of the fact that the domestic stock of gold (23,000-24,000 tonnes) lying with its households could be mon-etised. The reason for this late epiphany can be attributed to India’s then escalating current account deficit (CAD) on account of steady increases in gold import. India’s gold mines contribute to less than 0.5 per cent of total gold consumed ever year. In 2015, India mined less than 2 tonnes of gold.

It has been nearly impossible to calculate the exact amount of gold lying with households for two reasons. One, households have been accumulating gold for not just years, but for generations. Two, while we can estimate the amount of gold that enters the country through imports, it has been nearly impossible to factor in the exact amount of domestic gold that gets recycled every year through jewellery stores. Some estimates peg this figure at approximately 300 tonnes.

India’s appetite for gold is not expected to decline over the years. It, however, is in India’s interest to reduce dependence on imported gold. In the absence of diminishing demand, gold monetisation is the natural answer. Policies around gold monetisation had to address the duel objectives of monetising existing stocks of gold and of garnering investment demand for gold through new financial products.

1.2 Monetisation of Gold in IndiaThe lack lustre performance of existing gold monetisation schemes, the lack of participation of

retail customers, lack of innovative gold backed and gold related investment products and the increasing dependence on gold imports forced the government to re-examine its policy stance, or rather the conspicuous absence of one, on gold. India’s efforts towards monetising gold began with budget announcements made in 2015. In his budget speech, the Finance Minister alluded to the vast stocks of domestic gold lying in this country and in that context, made three very important announcements around the monetisation of gold.

1.2.1 Gold Monetisation Scheme (GMS)

The first was to revamp the existing Gold Deposit Scheme (GDS) and convert it into the Gold Monetisation Scheme (GMS) in the hope of encouraging more retail households to deposit their gold with a bank and gain interest on such deposits. In the earlier version of GDS, owing to the very high minimum deposit amounts of 500g and 1kg, the scheme only attracted institutional depositors. Earlier, Gold Deposit Scheme (GDS) and the Gold Metal Loan (GML) were two seperate products. It was only under the GMS that these two schemes have been linked and cumulatively christened GMS.

1.2.2 Sovereign Gold Bond (SGB)

The second was the introduction of a Sovereign Gold Bond (SGB) with the promise of it being available for all those who wanted to invest in a financial product which mirrored the price of gold.

The SGB is designed as a government security denominated in grams of gold, issued at the ongoing market price and the investor receives the ongoing

1. Overview


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market price during redemption or premature redemption of the bond. The price of the bond is fixed in Indian Rupees on the basis of the previous week’s (Monday-Friday) simple average price for gold of 999 purity, as published by the India Bullion and Jewellers’ Association Ltd. (IBJA). The issue price is publicised by the Reserve Bank of India (RBI). It is issued in denominations of one gram of gold and multiples thereof. The SGB further bears a fixed interest rate of 2.75 per cent (although it has been reduced to 2.5 per cent for the seventh tranche) per annum on the amount of initial investment, paid semi-annually to the investor. The tenure of the bond is typically 8 years, with an exit option from the 5th year onwards from the date of issue on coupon payment dates. It is transferable and is tradable on exchanges if held in dematerialised form. SGB is exempted from capital gains tax at the time of redemption. Recently, RBI announced that long-term capital gains arising from the transfer of SGBs will be eligible for indexation benefits.

The SGB evoked tremendous interest among investors on its launch in November 2015 and garnered a subscription of 915.95 kg worth INR 246.20 crore in its first tranche from as many as 62169 applicants. The second tranche in January 2016 surpassed the first tranche, collecting a further subscription for 2872.3 kg worth INR 746.80 crore from 3.16 lakh applicants. The third tranche, which was issued between March 8 and 14, 2016, received a lukewarm response from around 64000 applicants for a subscription of 1128 kg of gold amounting to INR 329 crore. Till date, SGBs have been issued for a total of 14071 kilograms of gold worth INR 4145 crore over six tranches. The seventh tranche was issued from February 27, 2017, to March 2, 2017 and the authorities are hopeful of seeing a spike in the subscription application.

The SGB scheme has been primarily targeted at the new age young investors who use gold mostly as a hedging instrument. The SGB offers the same benefit without actually buying physical gold and in the process also reduces the burden on the import of the yellow metal. Moreover, it is expected to shift a part of the domestic savings used for the purchase of gold into financial savings, thus positioning the SGB as a small saving instrument and promoting financial inclusion.

It is a considered to be a suitable investment substitute compared to physical gold with no risk in terms of storage and with assurance on the quality of gold compared to jewellery. The SGB can be also used as collateral for borrowing. Despite these advantages, SGB is yet to find its place in the regular retail investor’s portfolio, although it boasts of having performed better than the two other gold based schemes introduced by the government to undertake the monetisation of gold. Moreover, while the cumulative demand for SGB amount to a little less than15 tonnes of gold, it is also true that Indians buy as much as 200 tonnes of gold bars and coins every year as investment. This is the potential market for SGBs. The SGB is sold mainly through commercial banks, designated post office branches, offices of the Stock Holding Corporation of India Limited (SHCIL) and two major exchanges, the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) for now.

The reach of the SGB can further be enhanced with suitable alterations in policy.

a. Remove taxation of the interest payment: While the government had done away with the long-term capital gains (LTCG) tax arising on the redemption of SGBs and has provided indexation benefit to LTCG arising from the transfer of bonds, the paltry interest, which is

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less than the interest paid on a savings account in a bank, that is paid half yearly is still being taxed. This should be done away with.

b. Non Resident Indian’s (NRI’s) and foreign nationals should be allowed to buy: As of now, only Indian entities with valid Indian passports are allowed to buy SGBs. To boost its sales, it is imperative that NRI and foreign nationals are allowed to buy SGBs.

c. SaleofSGBsthroughnon-bankingfinancialcompanies(NBFCs),financialinstitutions(FI)and other institutions: At present, the sale of SGBs is permitted through banks, select PO branches, office of SHCIL and NSE and BSE. To further boost the sale of SGBs, NBFCs and other FIs should be allowed to sell these.

d. Suitable incentive for selling SGBs: Banks, FIs and other channels selling SGBs should be incentivised properly so that these entities are eager to sell SGB.

e. Need for better marketing: The government and RBI need to evaluate the marketing strategy for a product like SGB. Highlighting important aspects such as higher returns on gold price appreciation, exemption from long term capital gain tax, etc., instead of a 2.5 per cent interest rate will have a better impact on the investors.

1.2.3 India Gold Coin (IGC)The third was to introduce the Sovereign India Gold Coin (IGC). The IGC is a 24 carat pure gold coin with 999 fineness, promoted by the Government of India (GoI) and boasts of being the only Bureau of Indian Standards (BIS) hallmarked coin in India. The IGC is available in 5 grams, 10 grams and in bars of 20 grams, carries advanced counterfeit (security) features along with tamper proof packaging. The IGC is currently minted at the Security Printing

and Minting Corporation of India (SPMCI) and is supplied by the state-run Metals and Minerals Trading Corporation of India (MMTC).

India has never had a sovereign gold coin issued before. While customers are more than eager to buy these coins, the distribution channels for these coins have not been developed. Despite the fact that MMTC has tied up with a couple of banks to sell the IGC, the sale of these coins have not picked up. One of the primary reasons for this could be that the sale of IGC is linked to GMS. In other words, only those banks who partake in GMS, are allowed to sell IGC and sell an equal amount of gold as is collected through GMS. Beside, banks are not allowed to buy the coins from MMTC for sale to their customers. Rather, banks only act as agents of sale on the basis of a meagre commission. It was hoped that if such a coin is introduced and sold through financial institutions, then the demand for foreign gold coins would drop and domestic stocks of gold would be put to better use through the IGC. The success of IGC lies in increasing the number of distribution channels so as to make it popular among people. Additionally, MMTC should allow banks to buy these coins to sell it to their customers. The coins must be sold not just by banks, but by other financial institutions and even jewellers. MMTC should also look to sell the gold coin through e-retail channels, which have recently taken up sale of gold coins online. IGC requires a more co-ordinated marketing effort by GoI, MMTC and by those selling the coins.

Another handicap is that SPMCI, which mints IGC, does not have a London Bullion Market Association (LBMA) accreditation, which is accepted as the global standard for minting pure gold and precious metal. Due to the lack of LBMA credentials, the IGC may not be accepted at par with other gold


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coins minted worldwide. To avoid such hassles, the government must upgrade SPMCI, which is minting IGC, to an LBMA approved refinery at the earliest or shift minting of IGC to an LBMA approved domestic refinery. This will bring IGC at par with the global basket of national coins such as the American Eagle Coin (USA), the Maple Leaf Coin (Canada), and the Chinese Panda Coin (China) and boost investor confidence, even among foreign buyers.It is to be noted that Suisse gold coins, which were earlier sold by banks, prior to RBI banning sale of gold coins by banks, were also imported coins complying with LBMA fineness. Hence, it is obvious that investors will ask for a product, which is, if not better, at least at par with the earlier one. The minting of LBMA standard IGC will further discourage people from buying coins of lower standard or fineness.

1.3 Identifying the Binding Con-straintsIn November 2015, the three gold monetisation schemes were launched with the promise that the products would be transparently and easily available. Yet, for a variety of reasons, two of the three schemes met with limited success. Apart from the SGB, which has had some success, the IGC is yet to achieve its potential and the GMS is almost a non-starter. The success of the IGC has been hampered mainly by the lack of easy availability due to the lack of distribution channels (rather than a shortage of stock). So far, under the GMS, only around 6 tonnes of gold have been collected, largely from institutional sources. Retail stocks of gold are yet to be mobilised under the GMS.

Many constraints have been highlighted by various stakeholders for the limited success of the monetisation schemes. First, there is lack of

standardisation of gold in India when it comes to price and quality. Second, the infrastructure required for successful monetisation is yet to be scaled up. There are not many assaying centres, refineries or vaults to bring about efficiencies of scale in the value chain of monetisation. Third, the participation of financial institutions, banks especially, has been moderate at best. Last but not least, consumer awareness requires a lot more work. The sentimental attachment to gold in India is high and therefore, for any monetisation scheme to work, the marketing of the schemes is crucial. While all these are important, in the context of gold monetisation, there is one binding constraint, which is the lack of participation by banks in gold monetisation.

1.4 Objective and Methodology of StudyThe objective of this study was to identify the binding constraint for gold monetisation and examine the reasons for its existence and come up with suitable recommendations to remove the constraint so that gold monetisation may gain momentum.

When the three monetisation schemes were evaluated, one common thread that emerged was the role banks played. Taking a cue from Turkey, where monetisation of gold gained immense momentum when the Turkish banks actively participated in the process, we examined the role of banks in the context of gold monetisation in India. The SGB was a success because banks were used as the primary channel of distribution. Banks actively marketed the bond and hence, retail participation was tremendous. A similar trend was also visible in the case of the sale of IGC. In the case of IGC, MMTC was given the responsibility of minting and distribution of the coins. MMTC began by using

25

its existing channels for distribution. However, the sale of IGC did not take off. It was only in the last three months or so, when MMTC began to tie up with banks that the sale of IGC picked up momentum. In the case of GMS however, bank participation has been minimal, for various reasons. As a result, retail participation in GMS has been marginal. So far, the only contributors to GMS have been institutional depositors, which were temples specifically. Notwithstanding that, the true success of GMS should be measured through the incremental participation of retail customers, and for this, increased participation by banks in GMS is indispensable.

Having identified the lack of participation of banks as the binding constraint to gold monetisation,

specifically in the GMS, the next step was to delve into the issue to identify the causes for this constraint. For this purpose, a detailed primary survey of 42 banks, 14 refineries, 150 assaying centres and 500 jewellers was undertaken to capture the responses of all stakeholders, both up and down the value chain of GMS. Apart from the primary survey, detailed one on one interviews were conducted with several stakeholders. Further, three roundtables, one each in Mumbai, Bengaluru and Delhi, were held under Chatham House Rules, to further discuss the issues that emerged from the survey and to identify possible solutions to them. The subsequent chapters detail with the findings of our primary research, outlining the issues that have prevented the active participation of banks in GMS, and the possible solutions to these issues.

Chapter 2:Gold Metal Loan

Key Points

■ Most preferred channel of procurement of gold for jewellers is from the

domestic market, followed by the import of gold

■ Average gold imported by banks in the financial year 2014-15 was 639

tonnes

■ 172.5 tonnes of gold had been loaned out through GML in the FY2014-15

■ Of the 42 banks surveyed, 13 currently offer GML to 1165 jewellers

■ Of the 13 banks undertaking GML, only 5 banks undertook GDS

■ 46 per cent banks offering GML had no NPAs from GML, 8 per cent between

3.1 to 5 per cent

■ NPAs from GML for banks undertaking both GML and GDS higher than those

undertaking only GML

■ Banks stated that GML most likely way to utilise gold collected through GMS

29

2.1 Procurement of GoldIn 1990, India repealed the Gold Control Act of 1962. This led to the liberalisation of gold imports. Over the years, India’s appetite for gold has grown steadily and this demand has been met primarily through imports. Jewellers may choose to procure pure gold, gold dorés or unfinished gold jewellery. The choice of the channel of procurement, through imports or through the GML, or from domestic sources lies with the jeweller. Large and more

organised jewellers prefer to procure their gold through banks. They can either request banks to facilitate import of gold or they can opt for GML. During times of gold price volatility, GML was preferred over imports on consignment basis, as GML helped in managing price risks better.

Our survey of 501 jewellers in Figure 2.1 indicates that gold is usually procured on a monthly or quarterly basis. Jewellers also procure a large volume of unfinished and finished jewellery.

2. Gold Metal Loan

Figure 2.1: Average quantity of gold bought by jewellers

9

2. Gold Metal Loan

2.1 Procurement of Gold

In 1990, India repealed the Gold Control Act of 1962. This led to the liberalisation of gold imports. Over the years, India’s appetite for gold has grown steadily and this demand has been met primarily through imports. Jewellers may choose to procure pure gold, gold dorés or unfinished gold jewellery. The choice of the channel of procurement, through imports or through the GML, or from domestic sources lies with the jeweller. Large and more organised jewellers prefer to procure their gold through banks. They can either request banks to facilitate import of gold or they can opt for GML. During times of gold price volatility, GML was preferred over imports on consignment basis, as GML helped manage price risks better.

Our survey of 501 jewellers in Figure 2.1 indicates that gold is usually procured on a monthly or quarterly basis. Jewellers also procure a large volume of unfinished and finished jewellery.

Figure 2.1: Average quantity of gold bought by jewellers

Figure 2.2 indicates that the most preferred channel of procurement of gold for jewellers is from the domestic market, followed by the import of gold. GML is the least preferred channel of procurement. For gold monetisation to truly work, GML must be made popular.

15.45

7.34

14.3515.89

5.92

8.01

3.08

7.377.54

3.77674.2 293.8

7058.2

493

2868.7

352.6 123.59

3645.9

240

1834.6

0

1000

2000

3000

4000

5000

6000

7000

8000

0

2

4

6

8

10

12

14

16

18

Leasing & GoldMetal Loan

(GML)

Importing onConsignment

Buy-back fromCustomers

DomesticRefinery

Buying fromDomestic market

Peak Normal Peak Total Normal Total

N = 501

Source: PIF- BRIEF SURVEY


30

Figure 2.2 indicates that the most preferred channel of procurement of gold for jewellers is from the domestic market, followed by the import of gold. GML is the least preferred channel of procurement. For gold monetisation to truly work, GML must be made popular.

Banks play a central role in the business of gold. There are many products that banks offer around gold that can be seen in Figure 2.3.Clearly, import of gold is the most popular of the lot. Had it not been for the ban on the sale of gold coins (except for IGC), this too would have been popular. Sale of gold coins was a substantial contributor to the non-interest income for banks.

The preference for import of gold on consignment basis is greater than that for GML. Banks,

nominated agencies and star trading houses (STH) are responsible for the import of gold. RBI’s circular A.D. (G.P. Series) Circular No. 7, dated March 6, 1998, detailed four ways in which gold could be imported by banks:

• Import of gold on loan basis

• Import of gold on suppliers’ credit / buyers’ credit basis

• Import of gold on consignment basis

• Import of gold on unfixed price basis

Over the years, there have been several changes and restrictions brought about based on the eco-nomic priorities of the country, especially in the last three years. The restrictions on the import of gold were imposed to control the then escalating CAD and to dampen India’s increasing demand for gold

Figure 2.2: Sources of procurement of gold by jewellers

10

Figure 2.2: Sources of Procurement of Gold by Jewellers

Banks play a central role in the business of gold. There are many products that banks offer around gold that can be seen in Figure 2.3. Clearly, import of gold is the most popular of the lot. Had it not been for the ban on the sale of gold coins (except for IGC), this too would have been popular. Sale of gold coins was a substantial contributor to the non-interest income for banks.

Figure 2.3: Number of banks offering various gold products

1.331.04

1.33 1.36

1

1.33

1.781.7 1.781.96

2.292 2.08 2.15

3

2.2 2.31

0

1

2

3

4

Upto 6 Cr > 6 Cr to 12 Cr > 12 Cr to 24 Cr > 24 CrBuying from Domestic market Importing on ConsignmentBuy back from Customers Lease & Gold Metal Loan (GML)Gold Dore

N = 501

15

9

13

5

1011

12

Import ofGold

Outright Sale Gold MetalLoan

Gold DepositScheme

GoldForwardContracts

Gold Coin Gold Bond

N = 42


31

Figure 2.3:Number of banks offering various gold products

Figure 2.4: Reasons for not importing gold 10

Figure 2.2: Sources of Procurement of Gold by Jewellers

Banks play a central role in the business of gold. There are many products that banks offer around gold that can be seen in Figure 2.3. Clearly, import of gold is the most popular of the lot. Had it not been for the ban on the sale of gold coins (except for IGC), this too would have been popular. Sale of gold coins was a substantial contributor to the non-interest income for banks.

Figure 2.3: Number of banks offering various gold products

1.331.04

1.33 1.36

1

1.33

1.781.7 1.781.96

2.292 2.08 2.15

3

2.2 2.31

0

1

2

3

4

Upto 6 Cr > 6 Cr to 12 Cr > 12 Cr to 24 Cr > 24 CrBuying from Domestic market Importing on ConsignmentBuy back from Customers Lease & Gold Metal Loan (GML)Gold Dore

N = 501

15

9

13

5

1011

12

Import ofGold

Outright Sale Gold MetalLoan

Gold DepositScheme

GoldForwardContracts

Gold Coin Gold Bond

N = 42

11

The preference for import of gold on consignment basis is greater than that for GML. Banks, nominated agencies and star trading houses (STH) are responsible for the import of gold. RBI’s circular A.D. (G.P. Series) Circular No. 7, dated March 6, 1998, detailed four ways in which gold could be imported by banks:

Import of gold on loan basis

Import of gold on suppliers’ credit/buyers’ credit basis

Import of gold on consignment basis

Import of gold on unfixed price basis

Over the years, there have been several changes and restrictions brought about based on the economic priorities of the country, especially in the last three years. The restrictions on the import of gold were effected to control the then escalating CAD and to dampen India’s increasing demand for gold and her dependence on gold imports. Since then, many of these restrictions have been reversed. Yet, 27 out of 42 banks do not import gold. (Figure 2.4)

Figure 2.4: Reasons for not importing gold

Currently, as per a more recent Master Directive on the Import of Goods and Services (RBI/FED/2015-16/12 FED Master Direction No. 17/2016-17, updated last in January 12, 2017), states that nominated agencies, including banks, are allowed to import gold on consignment basis and to grant GML. Banks, however, are not permitted to buy gold from the domestic market.

1.2

1.6 1.7 1.7 1.75

Not Interested No Way To HedgeRisk

Not Authorised toImport

Bank Does notHave AdequateInfrastructure

Not A ProfitableBusiness

Mean Ranks



and her dependence on gold imports. Since then, many of these restrictions have been reversed. Yet, 27 out of 42 banks do not import gold. (Figure 2.4)

Currently, as per a more recent Master Directive on the Import of Goods and Services (RBI/FED/2015-

16/12 FED Master Direction No. 17/2016-17, updated last in January 12, 2017), states that nominated agencies, including banks, are allowed to import gold on consignment basis and to grant GML. Banks, however, are not permitted to buy gold from the domestic market.


32

Figure 2.5: Total volume of gold imported by banks (N=15)

12

Figure 2.5: Total volume of gold imported by banks (N=15)

Our primary survey of 42 banks suggested that banks typically import gold in anticipation of demand rather than wait for orders to be placed (Figure 2.5). It takes a bank anywhere between three to seven days to clear one consignment. Import volumes vary in peak and non-peak seasons. The peak season are in the months of August to November. Average gold imported by banks in the financial year 2014-15 was 639 tonnes and from April 2015 to December 2015 was 414.5 tonnes.

2.2 History of Gold Metal Loan (GML)

In March 1998 (with a further clarification in December 1998)1, RBI permitted a few banks and nominated agencies to import gold on loan basis for a maximum period of 180 days for onward lending to jewellery exporters. The scheme was named the Gold (Metal) Loan or GML. The valuation of the gold for the purpose of maintaining reserves were based on the London morning fix rate (presently, the LBMA Gold Benchmarking) on reporting Friday crossed with the closing dollar-rupee spot rate on the reporting Friday. The same rate was applied to translate gold loans to rupees for capital adequacy and balance sheet purposes. The interest accrued during the process was measured in grammage, although it was decided that it would be settled in cash, as jewellery exporters would not be able to settle the interest payment in gold. This worked in favour of borrowers (since the entire transaction occurs in grammages the price of gold does not matter) offering significantly low cost of funding as compared to buying gold outright with a rupee loan.

In 1999, the RBI decided to mobilise domestically held gold in the country and launched the Gold Deposit Scheme (GDS). The government had allowed banks to deploy the gold collected through GDS for four specific purposes:

1 Refer to RBI circular DBOD.No.IBS.1519/23.67.001/98-99 on Gold Loan on December 31, 1998

226

75.35

20 24 10

113

64.130 21 7

342

149.9

50 4517

247

91.5

40 297

0

50

100

150

200

250

300

350

400

Big Private Big PSU Foreign Banks Small Private Small PSU

Peak Season Non-Peak Season Last FY YTD (Apr 15- till date)


Our primary survey of 42 banks suggested that banks typically import gold in anticipation of demand rather than wait for orders to be placed (Figure 2.5). It takes a bank anywhere between three to seven days to clear one consignment. Import volumes vary in peak and non-peak seasons. The peak season are in the months of August to November. Average gold imported by banks in the financial year 2014-15 was 639 tonnes and from April 2015 to December 2015 was 414.5 tonnes.

2.2 History of GMLIn March 1998 (with a further clarification in December 1998)1, RBI permitted few banks and nominated agencies to import gold on loan basis for a maximum period of 180 days for onward lending to jewellery exporters. The scheme was named the

Gold (Metal) Loan or GML. The valuation of the gold for the purpose of maintaining reserves were based on the London morning fix rate (presently, the LBMA Gold Benchmarking) on reporting Friday crossed with the closing dollar-rupee spot rate on the reporting Friday. The same rate was applied to translate gold loans to rupees for capital adequacy and balance sheet purposes. The interest accrued during the process was measured in grammage, although it was decided that it would be settled in cash, as jewellery exporters would not be able to settle the interest payment in gold. This worked in favour of borrowers (since the entire transaction occurs in grammages the price of gold does not matter) offering significantly low cost of funding as compared to buying gold outright with a rupee loan.

____________________________________________________

1 Refer to RBI circular DBOD.No.IBS.1519/23.67.001/98-99 on Gold Loan on December 31, 1998

33

____________________________________________________

2 Refer to RBI notification RBI/2013-14/148A.P. (DIR Series) Circular No.15 on ‘Import of Gold by Nominated Bank/Agencies/Entities’ as on July 22, 2013

In 1999, the RBI decided to mobilise domestically held gold in the country and launched the Gold De-posit Scheme (GDS). The government had allowed banks to deploy the gold collected through GDS for four specific purposes:

a. Gold (Metal) Loans to the domestic jewellery industry

b. Gold (Metal) Loans to jewellery exporters

c. Outright sale of gold domestically

d. Sale of gold to other nominated banks

In September 2005, with growing requests from various banks and nominated agencies, RBI permitted them to extend GML to domestic jewellery manufacturers. This move was considered to be a major push towards improving the consumption value chain in the gems and jewellery manufacturing sector. Even the tenure for jewellery manufacturers for GML was increased to 270 days from the usual 180 days, although this timeframe was not changed for exporters.

In August 2013, to arrest the surging CAD, RBI in consultation with the government, raised the import duty on the precious metal. Furthermore, much to the chagrin of the jewellers across the country, the RBI imposed the 80:20 rule2 to discourage import of gold for domestic use. During this period, GML was temporarily discontinued as the gold loaned out was primarily acquired through imports. In May 2014, after reviewing the import scenario, the RBI re-allowed banks to offer GML from the 80 per cent portion available for domestic sales. The 80:20 rule was finally scrapped in November 2014, and GML was allowed to function as before.

2.3 Working of GMLGML initially proved to be a better option than outright purchase of gold, as neither the leasing banks nor the jewellers have to effectively take on the price risk during procurement of the gold.

Typically, a domestic bank (nominated agencies) determines the amount of gold to be procured for leasing in two different ways. The bank may receive prior requests from its clients (jewellers) before placing an order with an overseas supplier. This is called placing order on a back-to-back basis. Alternatively, banks may place an order with their overseas supplier estimating an amount on the basis of their monthly dealings. On receipt of an order from the domestic bank, the overseas supplier (consignee) dispatches the physical gold, which is received and stored at the warehouses of the Indian Customs Department. The domestic bank pays off the customs/excise duties and the gold is shifted (transported) to the warehouse of a holding agency (e.g. Brinks, SIS etc.), with whom the overseas supplier has a contractual tie up. The holding agency is responsible for the safekeeping of the gold until the domestic bank is able to arrange for the lease or sale of gold. Typically, the holding agency can hold the gold for a period of thirty to forty five days although this time frame may vary as per the agreement between the overseas supplier and the importing bank. In case the domestic bank is unable to sell or lease the gold in this period, a rather rare instance, the overseas bank further extends the holding tenure in consultation with the domestic bank.


34

On receiving a request from a jeweller, the domestic bank instructs the holding agency to release the gold for delivery to the jeweller. GML is sanctioned to a jeweller for a maximum period of 180 days with options for part payment and early repayment. The loan period commences on the day the gold is delivered to the jeweller. It is interesting to note that the gold arrives in the country without a tariff or a price tag.The jeweller can fix the price of the gold on any day during the 180-day loan period. Typically, a jeweller fixes the price of the gold (in part or full) when the price of gold is low in the international spot market. The total cost of gold is arrived at by adding the fixed price along with a premium charged by the overseas supplier. This premium consists of the cost of refining, vaulting, opportunity cost of holding, handling and logistics, insurance and other miscellaneous expenses which are incurred by the overseas supplier. Upon price fixing, the jeweller needs to make the payment in the next two days failing which the fixed rate will be annulled and new rates will be fixed. It is to be noted that in this whole process of GML the domestic bank does not take ownership of the gold at any point of time. The overseas supplier is the consigner while the jeweller is the consignee in the entire process.

Generally, the interest rate on GML offered by domestic banks varies between 2.5 to 4 per cent. The spread between the rates of interest (RoI) offered by overseas suppliers and domestic banks varies anywhere from 1 to 2 per cent. Banks usually ask for a stand-by letter of credit (SB/LC) for jewellers applying for GML. This can be attributed to the fact that there have been only a handful of cases turning into non-performing assets (NPAs) in GML so far. In the case of an NPA, the domestic bank is responsible for settling payment for the consignment, which is done as early as possible.

GML had proved to be quite advantageous for jewellers. The global bullion market, unlike the domestic bullion market, sees constant ups and

Overseas Supplier

Customs Warehouse

Domestic Bank(Nominated Agency)

Cust

oms &

Exc

iseDu

ty

Cost

(Pric

e +

Pre

miu

m)

Cost

(Pric

e +

Pre

miu

m-D

omes

tic B

ank

Char

ges)

Holding Agent

Jeweller

Gold

GoldGold

Figure 2.6: Diagrammatic representation of GML

35

downs in price. The advantage of GML over outright purchase is that, GML is offered on unpriced gold. Jewellers can borrow gold, make jewellery and sell them at a premium when the price of gold is high. Later, when the price of gold falls, the jeweller can fix the value of the gold and return the loan amount, in parts or in full.

2.4 Banks and GMLBanks prefer GML as it is a profitable business and has practically no risk of turning into an NPA. Figure 2.7 shows that, of the 42 banks surveyed, 13 banks are currently offering GML and have stated that they have 1165 jewellers (445 jewellers by big Public Sector Bank (PSB), 40 jewellers by small PSB, 600

jewellers by big private Banks, 40 jewellers by small private banks and 40 jewellers by foreign banks) as customers. In 2014-15, the same banks dealt with a total of 717 jewellers (445 jewellers by big PSBs, 22 jewellersby small PSBs, and 165 jewellers by big private banks, 30 jewellers by small private banks and 55 jewellers by foreign banks) from April 2015 till December 2015.

Figure 2.8 further shows 172.5 tonnes of gold had been loaned out through GML in the 2014-15 financial year and 97.3 tonnes from April 2015 till December 2015. Of this, an estimated 104.9 tonnes of gold were offered as loans in the peak season and 59.9 tonnes in the non-peak season.

Figure 2.7: Total number of jewellers banks dealt with

16

jewellers by small private banks and 55 jewellers by foreign banks) from April 2015 till December 2015.



Figure 2.8: GML in peak season vis-á-vis non-peak season

2.5 Non-Performing Assets Arising from GML

Pahle India Foundation’s (PIF) survey shows that of the 13 banks undertaking GML, only 5 banks undertook GDS. Figure 2.9 shows that of the 13 banks offering GML, 46 per cent banks responded that they had no NPAs arising from GML, 38 per cent of the banks said they have less than 1 per cent NPA from GML while 8 per cent stated that

445

40

600

40 40

445

22

165

30 55

Big PSU Banks Small PSU Banks Big Private Banks Small PrivateBanks

Foreign Banks

N=13

Last FY YTD

104.9

59.9

172.5

97.3

Peak Season Non-Peak Season Last FY YTD (April - TillDecember)

(N=13)



36

2.5 NPAs Arising from GMLPahle India Foundation’s (PIF) survey shows that of the 13 banks undertaking GML, only 5 banks undertook GDS. Figure 2.9 shows that of the 13 banks offering GML, 46 per cent banks responded that they had no NPAs arising from GML, 38 per cent of the banks said they have less than 1 per cent NPA from GML while 8 per cent stated that they have NPAs between 1.1 per cent and 3 per

cent and another 8 per cent between 3.1 - 5 per cent from GML.

When compared to NPAs arising from other loan products of banks, NPAs from GML was found to be negligible. What did however emerge was that NPAs arising from GML for those banks undertaking both GML and GDS was higher than those undertaking only GML. Figure 2.10 shows that 40 per cent of banks undertaking both GML and GDS


Figure 2.9: NPAs arising from GML

16

jewellers by small private banks and 55 jewellers by foreign banks) from April 2015 till December 2015.




2.5 Non-Performing Assets Arising from GML

Pahle India Foundation’s (PIF) survey shows that of the 13 banks undertaking GML, only 5 banks undertook GDS. Figure 2.9 shows that of the 13 banks offering GML, 46 per cent banks responded that they had no NPAs arising from GML, 38 per cent of the banks said they have less than 1 per cent NPA from GML while 8 per cent stated that

445

40

600

40 40

445

22

165

30 55

Big PSU Banks Small PSU Banks Big Private Banks Small PrivateBanks

Foreign Banks

N=13

Last FY YTD

104.9

59.9

172.5

97.3

Peak Season Non-Peak Season Last FY YTD (April - TillDecember)

(N=13)

17

they have NPAs between 1.1 per cent and 3 per cent and another 8 per cent between 3.1 to 5 per cent from GML.


When compared to NPAs arising from other loan products of banks, NPAs from GML was found to be negligible. What did however emerge was that NPAs arising from GML for those banks undertaking both GML and GDS was higher than those undertaking only GML. Figure 2.10 shows that 40 per cent of banks undertaking both GML and GDS claimed to have up to 1 per cent NPAs as opposed to 25 per cent of the banks undertaking only GML. In fact, 20 per cent of the banks offering both GDS and GML sometimes have NPAs as high as up to 3 per cent.

Figure 2.10: NPA arising out of GML in banks undertaking GDS vis-á-vis non-GDS

This trend can be problematic in the future. While currently GML is offered through imported gold, in the future, when gold monetisation does take off, it is the gold that is collected through GMS that will be lent onward as GML. If at that point the current trend of NPAs continues, banks that offer GMS will find it difficult to return the

38%

8%8%

46%

(N=13)Upto 1%

1.1 to 3%

3.1 to 5 %

No NPA (0%)

40%

0%

20%

40%

25%

13%

0%

63%

Upto 1% 1.1 to 3% 3.1 to 5 % No NPA (0%)

N (GDS=5, Non GDS=8)

GDS Non-GDS



37

claimed to have up to 1 per cent NPA as opposed to 25 per cent of the banks undertaking only GML. Infact, 20 per cent of the banks offering both GDS and GML sometimes have NPAs as high as up to 3 per cent.

This trend can be problematic in the future. While currently GML is offered through imported gold, in the future, when gold monetisation does take off, it is the gold that is collected through GMS that will

be lent onward as GML. If at that point the current trend of NPAs continues, banks that offer GMS will find it difficult to return the deposited gold, once again making them dependent on imported gold. This would clearly defeat the purpose of gold monetisation.

Notwithstanding this, banks stated that lending gold through GML emerged as the most likely way to utilise the gold collected through GMS


17

they have NPAs between 1.1 per cent and 3 per cent and another 8 per cent between 3.1 to 5 per cent from GML.


When compared to NPAs arising from other loan products of banks, NPAs from GML was found to be negligible. What did however emerge was that NPAs arising from GML for those banks undertaking both GML and GDS was higher than those undertaking only GML. Figure 2.10 shows that 40 per cent of banks undertaking both GML and GDS claimed to have up to 1 per cent NPAs as opposed to 25 per cent of the banks undertaking only GML. In fact, 20 per cent of the banks offering both GDS and GML sometimes have NPAs as high as up to 3 per cent.


This trend can be problematic in the future. While currently GML is offered through imported gold, in the future, when gold monetisation does take off, it is the gold that is collected through GMS that will be lent onward as GML. If at that point the current trend of NPAs continues, banks that offer GMS will find it difficult to return the

38%

8%8%

46%

(N=13)Upto 1%

1.1 to 3%

3.1 to 5 %

No NPA (0%)

40%

0%

20%

40%

25%

13%

0%

63%

Upto 1% 1.1 to 3% 3.1 to 5 % No NPA (0%)

N (GDS=5, Non GDS=8)

GDS Non-GDS



38

(Figure 2.11). The other likely utilisation methods in order of preference were selling to jewellers, lending to MMTC for minting IGC, using as statutory liquidity ratio (SLR) and selling to MMTC for minting IGC.

Figure 2.12 shows that of the 13 respondent banks dealing in GML, 15 per cent responded to

GML being a very popular product, 15 per cent responded to it being popular but a majority said that GML was not a very popular product among jewellers as a way of procuring gold.

Even so, 54 per cent of the banks undertaking GML claimed that they foresee the business of

Figure 2.11: Likely utilisation of gold collected as part of GMS

18

deposited gold, once again making them dependent on imported gold. This would clearly defeat the purpose of gold monetisation.

Notwithstanding this, lending gold through GML emerged as the most likely way to utilise the gold collected through GMS (Figure 2.11). The other likely utilisation methods in order of preference were selling to jewellers, lending to MMTC for minting IGC, using as statutory liquidity ratio (SLR) and selling to MMTC for minting IGC.


Figure 2.12 shows that of the 13 respondent banks dealing in GML, 15 per cent responded to GML being a very popular product, 15 per cent responded to it being popular but a majority said that GML was not a very popular product among jewellers as a way of procuring gold.

Figure 2.12: Popularity of GML among banks

Even so, 54 per cent of the banks undertaking GML claimed that they foresee the business of GML increasing over a period of time, of which 29 per cent further predicted a substantial rise in the popularity of GML (Figure 2.13). This indicates that

1.391.94 2.07

2.45 2.60

Lend gold as GML Sell gold tojewellers

Lend gold toMMTC for minting

IGC

Use gold as SLR Sell gold to MMTCfor minting IGC

(Mean Rank, where 1=Most Important)

Mean Ranks

15%

15%

39%

23%

8%(N=13)

Very Popular

Popular

Slightly Popular

Not Popular

Unfamiliar



18

deposited gold, once again making them dependent on imported gold. This would clearly defeat the purpose of gold monetisation.

Notwithstanding this, lending gold through GML emerged as the most likely way to utilise the gold collected through GMS (Figure 2.11). The other likely utilisation methods in order of preference were selling to jewellers, lending to MMTC for minting IGC, using as statutory liquidity ratio (SLR) and selling to MMTC for minting IGC.


Figure 2.12 shows that of the 13 respondent banks dealing in GML, 15 per cent responded to GML being a very popular product, 15 per cent responded to it being popular but a majority said that GML was not a very popular product among jewellers as a way of procuring gold.


Even so, 54 per cent of the banks undertaking GML claimed that they foresee the business of GML increasing over a period of time, of which 29 per cent further predicted a substantial rise in the popularity of GML (Figure 2.13). This indicates that

1.391.94 2.07

2.45 2.60

Lend gold as GML Sell gold tojewellers

Lend gold toMMTC for minting

IGC

Use gold as SLR Sell gold to MMTCfor minting IGC

(Mean Rank, where 1=Most Important)

Mean Ranks

15%

15%

39%

23%

8%(N=13)

Very Popular

Popular

Slightly Popular

Not Popular

Unfamiliar


39

Figure 2.13: Banks’ perspective over increase in popularity of GML

Figure 2.14:Banks’opinion for increase in GML (for banks responding in positive in Figure 2.13)

20


Figure 2.14: Banks’opinion for increase in GML (for banks responding in positive in Figure 2.13)

2.6 Jewellers and GML

Figure 2.15 shows that the smaller jewellers (turn-over of up to INR 6 crore) do not consider procuring gold through GML. Other jewellers, especially those with turnovers higher than INR 24 crore do procure gold through GML, but it is not the most popular channel of procurement. Jewellers prefer importing on consignment basis, buying from the domestic market or buying back from customers.

54%

46%

(N=13)

Yes No

29%

71%

If yes, by how much (N=7)

Drastically Slightly

20





54%

46%

(N=13)

Yes No

29%

71%



20





54%

46%

(N=13)

Yes No

29%

71%





GML increasing over a period of time, of which 29 per cent further predicted a substantial rise in the popularity of GML (Figure 2.13). This indicates that although not highly popular at present, GML does

have the potential to grow as a product of interest among jewellers if necessary policy changes are made.


40

2.6 Jewellers and GMLFigure 2.15 shows that the smaller jewellers (turn-over of up to INR 6 crore) do not consider procuring gold through GML. Other jewellers, especially those with turnovers higher than INR 24 crore do procure gold through GML, but it is not the most popular channel of procurement. Jewellers prefer importing on consignment basis over GML because buying from the domestic market or buying back from customers.

When jewellers were asked why they did not prefer the GML route, the most common reason

cited was the high cost of borrowing (Figure 2.16). However, jewellers who have availed or continue to avail of GML say that the good quality of gold and convenience and quicker delivery are strong incentives.

That gold procured through GML reaches jewellers faster is further validated by the fact that during peak seasons, 66 per cent of the respondent jewellers procure gold on daily basis through GML, highest among the rest of the sources of procurement (Figure 2.17). During the normal season, however, when time is not a constraint,

Figure 2.15: Channels used by jewellers to source gold

21


When jewellers were asked why they did not prefer the GML route, the most common reason cited was the high cost of borrowing (Figure 2.16). However, jewellers who have availed of or continue to avail of GML say that the good quality of gold and convenience and quicker delivery are strong incentives.

Figure 2.16: Reasons for not preferring GML over other sources of procurement

That gold procured through GML reaches jewellers faster is further validated by the fact that during peak seasons, 66 per cent of the respondent jewellers procure gold on daily basis through GML, highest among the rest of the sources of procurement (Figure 2.17). During the normal season, however, when time is not a constraint, they prefer to import on a consignment basis (Figure 2.18).

2 2.08 2.15

11.33

1.781.7 1.78 1.962.29

1.331.04

1.33 1.36

3

2.2 2.31

0

1

2

3

4

Upto 6 Cr > 6 Cr to 12 Cr > 12 Cr to 24 Cr > 24 Cr

Mean Ranks (1being most important)

Lease & Gold Metal Loan (GML) Importing on ConsignmentBuy back from Customers Buying from Domestic marketGold Dore

32%

33%

34%

13%

9%

55%

45%

77%

20%

13%

15%

10%

7%

39%

0% 20% 40% 60% 80% 100%

Lease & Gold Metal Loan (GML)

Importing on Consignment

Buying from Domestic market

Gold Dore

More Convenient Cost effective Quicker delivery

Less Documentation Good Quality


41

Figure 2.17: Periodical sourcing of gold in peak season vis-á-vis sources for procurement


22


Figure 2.18: Periodical sourcing of gold in normal season vis-á-vis sources for procurement

66%

15%24%

32%

3%

18%

65%37%

26%

55%

11% 8%

17%16%

36%

2% 13%

16%

6%

6%2% 5%

6%

1%13%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Lease & Gold MetalLoan (GML)



Domestic Refinery Buying fromDomestic Market

Peak

Daily Weekly Fortnightly Monthly Quaterly Ad-hoc

36% 38%29%

6%14%

30% 30%

14%

13%

14%

16%

22%

29%23%

9%28% 28%

23%

41%

7%5%

7%

6%

6%2% 1%

23%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%



Buy back fromCustomers

Domestic refinery Buying fromDomestic market

Normal




21


When jewellers were asked why they did not prefer the GML route, the most common reason cited was the high cost of borrowing (Figure 2.16). However, jewellers who have availed of or continue to avail of GML say that the good quality of gold and convenience and quicker delivery are strong incentives.


That gold procured through GML reaches jewellers faster is further validated by the fact that during peak seasons, 66 per cent of the respondent jewellers procure gold on daily basis through GML, highest among the rest of the sources of procurement (Figure 2.17). During the normal season, however, when time is not a constraint, they prefer to import on a consignment basis (Figure 2.18).

2 2.08 2.15

11.33

1.781.7 1.78 1.962.29

1.331.04

1.33 1.36

3

2.2 2.31

0

1

2

3

4

Upto 6 Cr > 6 Cr to 12 Cr > 12 Cr to 24 Cr > 24 Cr

Mean Ranks (1being most important)

Lease & Gold Metal Loan (GML) Importing on ConsignmentBuy back from Customers Buying from Domestic marketGold Dore

32%

33%

34%

13%

9%

55%

45%

77%

20%

13%

15%

10%

7%

39%

0% 20% 40% 60% 80% 100%

Lease & Gold Metal Loan (GML)

Importing on Consignment

Buying from Domestic market

Gold Dore

More Convenient Cost effective Quicker delivery

Less Documentation Good Quality


42

they prefer to import on a consignment basis (Figure 2.18).

2.7 Dwindling Popularity of GMLGML can be a win-win situation for jewellers because they can access gold easily in a transparent manner, pay-back the leasing agency in part or as whole post-sale of gold and, most importantly, hedge themselves against price risk. Banks, however, have repeatedly mentioned that there is no demand for GML from jewellers. The question that begs to be asked is why has the popularity of GML has gone down among jewellers in recent times?

The answer lies in the tenure of GML. The tenure of GML, currently at 180 days, has apparently been linked to the turnover cycle of jewellers. Before the

financial crisis set in, jewellers were able to sell their gold borrowed through GML within 180 days. However, in recent times, jewellers are unable to sell their inventory within 180 days. This has made GML a more expensive way to procure gold. In the interest of customer retention, jewellers cannot reduce their inventory either.

For gold monetisation to truly work, GML must become popular. For this purpose, the tenure of GML must be increased. Internationally, lease tenures for gold are driven by commercials rather than by regulations. As any other loan products offered by banks, GML must also be allowed multiple tenures that banks can fix and jewellers can opt for, based on commercial interests and business cycles.


22



66%

15%24%

32%

3%

18%

65%37%

26%

55%

11% 8%

17%16%

36%

2% 13%

16%

6%

6%2% 5%

6%

1%13%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%




Domestic Refinery Buying fromDomestic Market

Peak


36% 38%29%

6%14%

30% 30%

14%

13%

14%

16%

22%

29%23%

9%28% 28%

23%

41%

7%5%

7%

6%

6%2% 1%

23%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%



Buy back fromCustomers

Domestic refinery Buying fromDomestic market

Normal



Chapter 3:Gold Monetisation Scheme (GMS)

Key Points

■ All stakeholders agree that GMS will increase business volumes

■ GMS riddled with operational hurdles

■ No financial audit of CPTCs is undertaken

■ Credit rating for CPTCs must be undertaken

■ Jewellers missing link in GMS chain

■ Another drawback is banks have limited options for use of GMS gold

■ The need for more sophisticated product offerings such as interbank,

dollar, and foreign currency swaps

■ Allow NBFCs to also participate in GMS

45

3.1 Evolution of GMSThe Gold Monetisation Scheme (GMS) is the overhauled version of the Gold Deposit Scheme (GDS). The basic objective and contours of the two

products are similar. The GMS has eased eligibility norms for investors and has paid greater attention to procedures to foster transparency and trust in the system. Table 3.1 lists out the basic differences between erstwhile GDS and the R-GDS

3. Gold Monetisation Scheme

Table 3.1 Basic differences between GDS and R-GDS

Gold Deposit Scheme Revamped - Gold Deposit Scheme

Scheme Only deposit taking scheme.A combination of Gold Deposit Scheme and Gold (Metal) Loan.

TenureTenure varied from 3 to 7 years, with an initial lock-in period specified by the bank undertaking the scheme.

Tenure has been categorised into short term of 1-3 years with a roll out in multiples of one year, medium of term 5-7 years and long term of 12-15 years.

QuantityThe minimum quantity needed to participate was 500 grams.

The minimum quantity needed to participate is as less as 30 grams.

Assaying

Banks would tie up with a refinery or an assayer of their choice to undertake assaying of gold. Alternatively, it could use the infrastructure set up of a different banks. Typically, it would take anywhere between 4-7 days.

BIS approved collection and purity testing centres (CPTCs) to carry out preliminary testing through XRF and weighing. On the consent of customer after valuation, jewellery is sent for melting to a refinery. The customer can take the gold back post assaying if he/she is not happy after paying a nominal charge for assaying. Process takes a total of 3-4 hours.

Rate of Interest (RoI)

Decided by banks in tune with their own costing.

For short term: Decided by banks on basis of prevailing international leasing rates, market conditions, etc., and will be denominated in grammage.

For medium and long term: To be decided by GoI along with RBI and payable in rupees, based on the value of gold.

RedemptionTo be made in cash equivalent to the price of gold as on the date of encashment or in gold.

For short term: Both principal and interest can be redeemed in gold or rupees, which has to be mentioned by customer when making the deposit.

For medium and long term: Redemption will be made in rupees only, although interest will be earned based on the value of gold.


46

All stakeholders, banks, assaying units, refiners, and jewellers agree that GMS will increase their respective business volumes. They are also in universal agreement that GMS will benefit consumers. Notwithstanding this collective optimism, GMS has not taken off. The challenges seem to be largely operational.

Banks are central to GMS. Only through their proactive participation will GMS be successful. Banks, though not sceptical, have raised many operational issues that have forestalled them from actively marketing GMS to their consumers. Figure 3.2 lists the deterrents to the success of GMS.

Figure 3.1 Advantages of GMS (N=42)

Figure 3.2 Deterrents to success of GMS (N=42)

25





1.381.89

2.422.80 3.00 3.00 3.00

3.50

Curb goldimports andreduce thecountry's

dependenceon the import

of gold insome years

Increase country’s economic

growth

Provideopportunity

for householdsto earn interest

on theirdomestic stock

of gold

Increasenational rateof financial

savings

Create moreemployment

Provide bankswith an

additionalsource ofincome

Reduce thecost of

borrowing ofgold forjewellers

Will increasethe rate offinancialinclusion

1.481.72

2.25 2.25 2.27 2.33

2.67

Emotionalattachment withgold may cause

problems

Operationalchalleges

The demand forgold under GML

is low

No uniformprice for gold

Not enoughassaying units &

hallmarkingcentres

Rate of interestsuggested bybanks may be

low

Not enoughrefineries

25





1.381.89

2.422.80 3.00 3.00 3.00

3.50

Curb goldimports andreduce thecountry's

dependenceon the import

of gold insome years

Increase country’s economic

growth

Provideopportunity

for householdsto earn interest

on theirdomestic stock

of gold

Increasenational rateof financial

savings

Create moreemployment

Provide bankswith an

additionalsource ofincome

Reduce thecost of

borrowing ofgold forjewellers

Will increasethe rate offinancialinclusion

1.481.72

2.25 2.25 2.27 2.33

2.67

Emotionalattachment withgold may cause

problems

Operationalchalleges

The demand forgold under GML

is low

No uniformprice for gold

Not enoughassaying units &

hallmarkingcentres

Rate of interestsuggested bybanks may be

low

Not enoughrefineries



47

3.2 The ProcessThe current procedure for GMS can appear to be onerous for the retail investor. The investor can approach either a bank or a Collection and Purity Testing Centre (CPTC) with the gold they wish to deposit. Investors in India tend to prefer visiting banks due to high confidence level in these institutions. Banks will eventually direct the consumers to the CPTC with whom they have a tie-up. At the CPTC, a preliminary test of the gold is undertaken with the use of XRF machine. At this stage, the gold is not melted, merely placed on the machine. An estimate of purity is provided to the customer. At this stage, the customer can either take their gold back or they can grant permission to the CPTC for a more rigorous purity test that requires melting. Once permission to melt is obtained by the CPTC, the gold is melted in an induction furnace and then homogenised. The weight of gold before and after melting is recorded. A sliver of this homogenised gold is retained by the CPTC and the unrefined, homogenised gold is then packed into a tamper proof packet and sent to the refinery. The refinery is obliged to hold on to this packet without opening it for forty-eight hours as per BIS guidelines. The CPTC, in the meanwhile, provides the customer with a certificate of purity. The customer is then required to submit this certificate to the bank. Based on the valuation provided by the CPTC, the appropriate grammage of gold is deposited into the customer’s account. The bank treats this credit as provisional until the refinery has refined the gold received from the CPTC and corroborated the valuation provided by the latter. If there is any variation in the valuation of the refinery of over 0.5 per cent, then a third party audit of the gold is conducted using the sliver retained by the CPTC and that with the refiner. If the CPTC’s valuation is incorrect, their licence is cancelled. As

per guidelines issued by the RBI on GMS, the bank is required to provide a final credit of grammage into the customer’s deposit account no later than a month from the time of opening the GMS account. The refinery, in the meanwhile, refines the gold, converts it into standard sizes and sends it to the bank. The bank may then utilise this gold as per the guidelines provided by RBI.

3.3 The ProblemsThe already tedious process of GMS is also riddled with many operational hurdles. Despite having lowered the minimum deposit amount from 500 grams of gold to 30 grams of gold, banks have been unable to generate retail participation. Thus far, the only contributions that banks have received for GMS have been from temples. As mentioned earlier, banks are hesitant to market GMS to its retail participants on account of many unresolved operational issues.

The guidelines initially recommended that banks, refineries and CPTCs get into a tripartite agreement. Such an agreement was expected to reduce operational inefficiencies and foster trust between the three crucial players in GMS. This, however, has not materialised to the extent envisaged. There have been very few successful tripartite agreements. The guidelines were later revised to encourage bipartite agreements between banks and refineries to provide an impetus to GMS collections. The pain point of the tripartite agreement was the CPTCs.

For any existing hallmarking centre to become a CPTC, it has to have the following four facilities – a balance for measurement, an induction furnace, a viewing gallery and a fire assay. While the BIS does a thorough job of auditing equipment and processes at the hallmarking centres before granting them a CPTC licence, no financial audit of CPTCs is


48

undertaken. Banks, therefore, are uncomfortable about taking any credit exposure that can expose banks to credibility risks. Due to lack of deposit volumes, gold collected at the CPTCs may not be sent to the refineries the same day. In the interest of minimising transportation cost, CPTCs may wait until minimum volumes are accumulated before dispatching the lot to refineries. Until such time, the gold will remain with the CPTCs. While a tripartite agreement can protect the bank to some extent from any fraudulent activity on the part CPTCs, banks consider the risk too high. Therefore, for a more seamless relationship between banks and CPTCs, two suggestions have been made. The first is that CPTCs should provide an initial guarantee equivalent to 30 per cent of the agreed exposure limit, which is usually up to one kilogram of

gold. The second was to come up with a suitable mechanism of credit rating for CPTCs, which would automatically entail a financial audit. CPTCs are willing to provide a guarantee to banks. However, as there are only few licenced CPTCs, they have or are likely to have arrangements with several banks. Most CPTCs, though willing, do not have the financial wherewithal to provide guarantees to several banks.

Another impediment to GMS has been the unwillingness of banks to treat CPTC valuations as accurate valuations, even though guidelines specify so. Banks wait for refineries to send in their valuations before confirming the valuation to the customer. While the bipartite agreements between banks and refineries have helped ease purity valuations in GMS, for scalability to be achieved, it is

Figure 3.3: Awareness among jewellers regarding GMS (categorised by turnover of jewellers)

28

furnaces that can melt gold in seconds, after which they often test the purity of the gold using XRF machines.


Figure 3.4: Impact of GMS on business (by turnover of jewellers)

50%66%

32%

62%54%

50%

34%

68%

38%46%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Upto 6 Cr > 6 Cr to 12 Cr > 12 Cr to 24 Cr > 24 Cr Total

Yes No

51% 45%

74%

45% 50%

7% 21%

13%

26% 18%

41%34%

13%

29% 32%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Positive Negative No Change


49


28

furnaces that can melt gold in seconds, after which they often test the purity of the gold using XRF machines.



50%66%

32%

62%54%

50%

34%

68%

38%46%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Yes No

51% 45%

74%

45% 50%

7% 21%

13%

26% 18%

41%34%

13%

29% 32%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Positive Negative No Change


paramount for CPTCs to be involved in the process. Currently, refineries are not in a position to set up multiple collections centres across India. In order to solve the problem of scalability of CPTCs, BIS has now allowed jewellers to set up collection centres.

3.4 The Role of Jewellers in GMSJewellers are the missing link in the current GMS chain. In India, consumers trust jewellers. The relation between consumers and their jewellers often run through generations. Jewellers also have the capacity and capability to market GMS and convince their consumers to participate in GMS. Jewellers offer valuations on consumer’s gold on a daily basis. They do not use a fire assay, but they do have electric furnaces that can melt gold in seconds, after which they often test the purity of the gold using XRF machines.

BIS has allowed jewellers to participate in GMS by becoming CPTCs. However, thus far, only one jeweller has come forward. Jewellers have been apathetic to becoming CPTCs possessing a fire assay,for two reasons. One, they do not believe that a fire assay is essential to offer a fair valuation to the consumer. Two, as jewellery shops are in residential areas, suitable environmental clearances for housing a fire assay may be difficult to obtain. The arduous and tedious procedural complications has precluded jewellers from participating in GMS.

3.5 Making GMS WorkThere are broadly two drawbacks in the current structure of GMS. The first lies in the inefficiencies in the gold value chain. Logistical hurdles have dampened retail participation. Jewellers doubling up as CPTCs will certainly help in increasing the reach of GMS to retail customers. For this purpose,


50

the need for a fire assay must be re-examined. Due processes can be put in place to ensure that the interests of consumers are protected. For example, when a retail consumer brings in gold for assaying to a jeweller-CPTC, the jeweller can assay the gold using an XRF (X-ray fluorescence) machine, before and after melting, subject to the consent of the consumer. The consumer can be educated about the possible margin of error that may arise between the valuation of gold through an XRF unit and through a more thorough process carried out either through a fire assay or at the refinery. Should the customer not be satisfied, they can always opt for a fire assay test at a CPTC. If not, the jeweller-CPTC’s valuation is deemed acceptable by the consumer and sent to the bank. A consumer may opt for the valuation offered by jewellers for two reasons – one, it would save them the effort of having to find a CPTC and take their valuables to an area that is unfamiliar to them, and two, consumers are more likely to trust their jeweller’s valuation due to a pre-existing relationship.

The second drawback lies in the lack of options available to banks for use of gold collected through GMS. In March 2016, the RBI in their frequently asked questions (FAQ), did clarify that gold collected

by banks through GMS could be used for interbank-lending. This was already permissible under the erstwhile GDS but did little to encourage banks to offer GDS. The need of the hour is for more sophisticated product offerings such as interbank swaps and foreign currency swaps such as dollar swaps.

Interbank lending of gold collected through GDS was allowed under GDS and has also been allowed for GMS. However, not many banks have availed of this option as a way of utilising collected gold. The most commonly cited reason for this was lack of awareness, lack of regulatory clarity and the absence of necessary guidelines from RBI.

Other enabling provisions that could help GMS are:

1. To allow for CPTCs to either be credit-rated or to ensure that a financial audit is conducted to help banks and refiners better assess their respective counterparty risks with CPTCs.

2. To allow NBFCs to also participate in GMS by allowing them to collect gold. The regulator may provide eligibility guidelines for NBFC participation.

3. For India to reduce her dependence on imported gold, recycling of domestic gold is necessary. While GMS will help in bringing

Figure 3.5: Reasons for never entering into interbank swaps (mean ranks)

30

Figure 3.5: Reasons for never entering into interbank swaps (Mean Ranks)

Figure 3.6: Perceptions (Positive Responses)

11.3

1.61.9 2

2.6

Not aware No regulationfrom RBI

Difficult to arriveat negotiation price

No such productavailable

Not cost effective No suitablepartner

10%

26%

38%

48%

50%

50%

62%

62%

67%

67%

74%

81%

88%

90%

That GMS will be successful without the activeparticipation of banks

Banks will be able to derive a profitable income fromGMS in the medium to long term (say 3-5 yrs)

The GMS in its current form will be successful in India

Will banks be willing to enter into rupee swaps againstgold with NBFCs

Participation of NBFCs in GMS will make it moresuccessful

Allowing participation of NBFCs in GMS, will reducethe cost for banks

NBFCs should be allowed to enter GMS

RBI should offer short term (3-6 months) forex swapsagainst gold with banks

Banks should be allowed to buy back gold coins that arehallmarked, branded and in tamper-proof packaging

Allowing domestic interbank swaps, thereby makingsome banks a collection point for gold deposit & others

as lenders of gold is a good idea

Banks should be permitted to buy back ‘India Gold Coins’

Banks should be allowed to participate in domesticcommodity markets (for gold only)

Bank does have the requisite technical knowledge toimplement the scheme

Jewellers should be allowed to act as collection pointsfor GMS


51

Figure 3.6: Perceptions (positive responses)

30

Figure 3.5: Reasons for never entering into interbank swaps (Mean Ranks)

Figure 3.6: Perceptions (Positive Responses)

11.3

1.61.9 2

2.6

Not aware No regulationfrom RBI

Difficult to arriveat negotiation price

No such productavailable

Not cost effective No suitablepartner

10%

26%

38%

48%

50%

50%

62%

62%

67%

67%

74%

81%

88%

90%

That GMS will be successful without the activeparticipation of banks

Banks will be able to derive a profitable income fromGMS in the medium to long term (say 3-5 yrs)

The GMS in its current form will be successful in India

Will banks be willing to enter into rupee swaps againstgold with NBFCs

Participation of NBFCs in GMS will make it moresuccessful

Allowing participation of NBFCs in GMS, will reducethe cost for banks

NBFCs should be allowed to enter GMS

RBI should offer short term (3-6 months) forex swapsagainst gold with banks

Banks should be allowed to buy back gold coins that arehallmarked, branded and in tamper-proof packaging

Allowing domestic interbank swaps, thereby makingsome banks a collection point for gold deposit & others

as lenders of gold is a good idea

Banks should be permitted to buy back ‘India Gold Coins’

Banks should be allowed to participate in domesticcommodity markets (for gold only)

Bank does have the requisite technical knowledge toimplement the scheme

Jewellers should be allowed to act as collection pointsfor GMS


existing gold stockpiles into the financial market, this gold must be lent out to jewellers in order to meet new demand for gold. It is only then that existing reserves will be recycled. For this to take place, GML must be re-examined. Our survey results indicate that banks are willing to offer GML to jewellers

and that it is the lack of demand for GML by jewellers that has prevented this product from reaching its potential. In order to popularise GML among jewellers, RBI should allow banks to decide on the tenure for providing GML and offer flexi tenures so that the cost of borrowing gold through GML is also rationalised.

Chapter 4:Gold Exchange and Gold Regulations

Key Points

■ India needs a formal trading place that facilitates transparent buying

and selling of gold

■ Such a platform will help in price discovery and ensure better

integration with financial markets

■ Almost all gold transactions take place in the unorganised market

■ India does not have a spot market for gold

■ The lack of standardisation of gold purity has been a big hurdle

■ Regulatory framework also not very clear

■ Bullion must be defined as a separate category of commodity

■ Draft regulatory framework may nudge the private sector to set up spot

trading exchanges

55

4.1 Gold Exchanges around the WorldWith the global economy drivers shifting from the American and European nations to Asian economies after the global meltdown, the demand for gold and gold-backed products have increased. Gold has always been considered a safe haven for preserving the value of money. Countries such as Turkey, Dubai, and China noticed this upswing in the demand for gold and created the necessary infrastructure to control the supply of gold among Asian countries and dominate the global gold market. One of the first steps toward this was the setting up of gold exchanges.

4.1.1 Case of Turkey

Turkey was the first country to set up a dedicated exchange to trade gold in a transparent manner. It was in 1995, that the Istanbul Gold Exchange (IGE) was established, which created a link between the precious metal market and financial market in Turkey. The creation of a strong gold infrastructure helped generate trust in the domestic market and encourage investment. Moreover, standardisation of gold prices created an efficient market and facilitated the monetising and recycling of gold in Turkey. This, in turn, positioned Istanbul as a global gold centre in the modern world. Although IGE was later merged with the İstanbul MenkulKıymetlerBorsası (also known as Istanbul Securities Exchange) and the VadeliİşlemveOpsiyonBorsası (also known as Futures and Options Exchange) creating the Borsá Istanbul (BIST), it helped Turkey create a niche area for itself as one of the global leaders in gold trading.

4.1.2 Case of Dubai

Dubai, on the other hand, had always maintained its status quo of being the traditional trade hub in Asia. It took a step ahead and set up the Dubai Gold and Commodities Exchange (DGCX), which started trading way back in November 2005 and is considered to be one of the leading derivative exchanges today. It has a wholly owned subsidiary, the Dubai Commodities Clearing Corporation, for undertaking clearing, settlement and risk functions. DGCX reported the exchange of 9.5 million contracts in the first half of 2016, the highest till date. Ironically, the growth of the gold business in India is what fuelled the growth in Dubai.

4.1.3 Case of China

In 2001, China, after abolishing its retail price control on gold, established the Shanghai Gold Exchange (SGE). The SGE was opened on a pilot basis for a year before it started official trading. It is to be noted that most of China’s gold flow, whether domestically produced, recycled, or imported compulsorily, pass through the SGE. To popularise the concept and boost trading, market participants are exempted from value added tax (VAT). The SGE executes transaction through price matching and price asking, provides venues, facilities and related services for trading in listed products, designs products to be traded, arranges the listing of products, adopts trading rules, and organises, supervises, and regulates transactions, settlements, delivery and other related business activities; drafts standards for construction of gold market infrastructure, formulates delivery standards, provides trade registration as well as services

4. Gold Exchange and Gold Regulations


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pertaining to accounts, custody, delivery, clearing and settlement, storage and transportation, and pledging and leasing; and monitors the quality of gold traded through the platform, allowing trading of only LBMA approved gold of 99.95 per cent purity or above. In 2012, over-the-counter (OTC) inter-bank trading was permitted, cleared through the SGE. In 2015, SGE launched its own price index, i.e., the Shanghai Gold Benchmark Price denominated in Chinese Yuan. The aim was twofold – first, to improve the position of the yuan in the global market, thus reducing its dependency on the US dollar; and second and more importantly, to move away from the age old London Price Fix (now the LBMA Gold Benchmarking) and create a price fix for China, that other Asian countries would adopt for trading gold among themselves. As the largest importer of gold, the Shanghai Gold Benchmarking may well influence gold prices around the globe. This last move is expected to put China in a position to control the trade in gold in the Asian sub-continent.

4.1.4 Case of Singapore

Not too far from China, Singapore launched the world’s first physical precious metals exchange with peer-to-peer bullion trading capabilities integrated into the trading platform. The Singapore Precious Metals Exchange (SGPMX) was opened on July 3, 2013 and since then, has been enabling traders to possess the physical commodity, be it gold, silver or any other metal. The SGPMX combines multiple trading operations such as retail sale, storage and vaulting, apart from functioning as a regular exchange where both individual and institutional investors can buy and sell gold and other metals. The Singapore Government, on its part, had erased the 7 per cent sales tax on certified gold and precious metal. This move certainly seemed to have

a stimulating effect on the local market and boost investor confidence, as the gold business has been increasing at a steady pace. Further, a world class refinery had been set up by a Swiss company called Metalor, which cast its first gold bar on June 13, 2013. It has been reported that the refinery started taking orders from customers, which included both long term retail and institutional investors, even before full deployment. Singaporean banks are actively starting with vaulting facilities to store gold for their investors. The Singapore Government, as well as other major partners like the Economic Development Board Singapore and International Enterprise Singapore, have been extremely supportive in all these initiatives. Needless to say, Singapore is making every effort to be a major hub for trade in the Asian gold and precious metal trading market.

4.2 Why India Needs a Gold Ex-change?Despite being one of the largest consumers of gold, next only to China, and with an annual demand of close to 1000 tonnes, our country lacks an efficient gold ecosystem. There are several functional gaps in the Indian gold market, with significant variations in the price and quality of gold across channels and points of sale (PoS). Jewellers prefer to buy certified gold from established agencies abroad because of which the country is heavily dependent on import for its gold consumption. Even the various government schemes such as the erstwhile GDS or the recently launched GMS failed to woo the average consumer to invest their gold in these schemes for several reasons. The average consumer is left with no choice but to sell it to the jewellers from whom she bought the gold from or to hold it in her locker. A formal trading place that facilitates transparent buying and selling of gold is what is

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necessary in India. Such a platform can help in price discovery, remove price disparities, establish quality control and ensure better integration with financial markets creating a better gold recycling process and creating a robust gold ecosystem.

4.3 Options for IndiaIt is quite evident that India needs a platform to provide a transparent trading (buying and selling) framework, establish a price discovery mechanism, bring out transparency in dealing, assure quality control and create a vibrant gold ecosystem that moves in tandem with the financial market.

4.3.1 Gold Spot Market or Spot Platform

India’s commodity spot markets are mainly of three types, agricultural commodities, non-agricultural commodities and bullion. Of these, and relatively speaking, the market for agricultural commodities is probably the most “organised”. Every state has several mandis or markets in which agriculture commodities are bought and sold on a daily basis. These agricultural mandis or markets are regulated by the Agricultural Produce Marketing Corporation (APMC) Act. Since commodities are State subjects, each State has its own version of the APMC Act, or none at all. Notwithstanding the many shortcomings of the mandi or the APMC Act, agricultural commodities atleast have an organised platform on which they can be traded. The number of spot transactions in gold alone on a year-on-year basis averages 700-900 tonnes, depending on import volumes. Almost all gold transactions take place in the unorganised market. Despite being one of the largest consumers of gold, India does not have a spot market for gold. In the absence of an organised bullion spot market, the gold market in India lacks a uniform price fixing mechanism.

There have been many deterrents in the past that have prevented gold spot markets from developing. Ironically, they have not been regulatory in nature. The lack of standardisation of gold purity has been a big hurdle that has prevented any organised spot market from developing. The lack of standards and the trust deficit that it has given rise to have prevented participants from either setting up or trading on the market. Having said this, the regulatory framework for setting up a gold spot exchange is not very clear. Under the current regulatory architecture, there are no regulations that guide the functioning of spot markets. Infact, spot markets, including bullion, are not regulated by any of the financial sector regulators. it is currently under the purview of the Department of Consumer Affairs (DCA) under the Ministry of Consumer Affairs, Food and Public Distribution.

Bullion should not be treated on par with agricultural commodities, or even non-agricultural commodities. Bullion or precious metal (gold, silver, platinum and palladium) must be a separate category and one that must be spelt out clearly under the Union List. Under India’s federal structure, while banking, insurance, stock exchanges and futures markets fall under the Union List, commodities do not find any mention in the Union List specifically. While the futures market for commodities are under the Union List, the spot market, by virtue of being classified as trade and commerce, falls under the State List. This can present complications for gold monetisation. First and foremost, because bullion has not been defined separately, it may become difficult to reconcile the regulations that would cover gold as a financial asset and gold as a commodity. For the purpose of gold monetisation, all gold must be viewed as a prospective financial asset and hence must be


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moved to the Union List. Moreover, the regulation of gold spot market should be moved under the purview of either the Ministry of Finance (MoF), Ministry of Commerce (MoC), Securities Exchange Board of India (SEBI) or a suitable financial regulator.

Even though there are no regulations for the spot market and, ideally speaking, none may be required, a draft framework or guidelines for operations, issued by the MoF, may nudge the private sector to set up spot trading exchanges or platforms.

4.3.2 Gold Derivatives Market

The gold futures market has been vibrant. Transaction volumes are significantly high with participation from players across the gold value chain. The futures market offers various rupee denominated contracts of various lot sizes, apart from providing the opportunity to hedge risks. The economy had partial success in creating a sustainable gold ecosystem when the commodity exchanges started offering gold contracts and creating a better price discovery mechanism. However, the introduction of commodity transaction tax (CTT) in 2013-14 had a detrimental effect on the volume of trade in commodity exchanges by as much as 41 per cent in that year and 42 per cent the following year. Moreover, the revenue generated through CTT was not even close to the government’s earlier estimates as trading volume drastically fell post implementation of CTT.

The worst affected was the gold futures market. Despite the fact that the gold futures were delivery based contracts, CTT was applicable. The average daily turnover for gold futures on Multi Commodity Exchange of India Limited (MCX), India’s largest bullion commodity exchange by turnover, fell by as much as 65 per cent within three quarters of CTT being imposed, including a more than 50 per cent decline in the number of clients trading in gold futures. Initial research suggests that CTT has moved out the gold futures market to exchanges based outside India, or worse, into informal markets. Another major consequence of CTT has been the drastic increase in the cost of transactions on the Indian exchanges (Table 4.1).

Countries such as China and Turkey and even Dubai, have monetised their gold stocks successfully. Price discovery has been the first step, which means moving the entire volume of OTC trade to the exchanges. For the success of gold monetisation, it is imperative that CTT on gold futures be removed. This move alone would induce many erstwhile traders, exporters, jewellers and their likes to return to the exchange. Since the gold futures contracts are all delivery based, the market is more likely to attract hedgers rather than pure speculators. A vibrant gold futures market is essential because it leads to transparent price discovery. It is only through transparent price discovery that consumer trust will be won and trust is most definitely a prerequisite for gold monetisation.

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Table 4.1: Comparative cost of hedging on exchanges

Source: MCX/Pavaskar and Ghosh (2008)*3

Gold (1 kg) hedging cost in rupees (buy and sell)CME DGCX

Post-CTT Pre-CTT

(Contract value=apprx. Rs. 31.5 lakh) MCX MCX

Transaction Fee 70.3 46.2 116.6 116.6

Clearing Fee 13.2 - -

Stamp Duty - - 63.0 63.0

Service Tax - - 17.5 17.5

CTT - - 315.0 0.0

Regulatory Fee - 4.0 12.6 -

Total Hedging Cost (in Rs.) 70.3 63.4 524.6 197.0

Indian post-CTT transaction cost as against the international counterpart

747% 828%

Note:

1. The transaction and clearing charges on CME for non-members (for which category the transaction fee is among the highest) is USD 1.45 each for a lot of 100 troy ounces.

2. For a comparative analysis, the transaction charges of CME are converted into INR for a contract value of INR 31.5 lakh – the approximate value of 1 lot gold traded at MCX.

3. DGCX too charges a transaction fee on per lot basis. The trading and clearing fee are USD 0.35 and 0.1 respectively, whereas the regulatory fee in the UAE is USD 0.03 per lot. The DGCX charges are also converted into INR or a contract value of INR 31.5 lakh.

4. USD/INR Rate of 66 is considered for all the calculation

____________________________________________________

3 Pavaskar, M. and Ghosh, N., 2008, Commodity Transaction Tax: A Recipe for Disaster, Economic and Political Weekly

Chapter 5:Bullion Banking in India

Key Points

■ Banks play a crucial role in integrating gold with the financial sector.

■ Bullion banking is a well-established concept among developed

economies

■ In India, bullion banking is yet to become an established concept

■ RBI can issue guidelines for bullion banks under differentiated banking

licences

■ A bullion bank can be a ‘one-stop’ shop

■ Bullion bank can provide fresh impetus to gold monetisation

programme

■ India’s own bullion bank can participate in the global price discovery

mechanism

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At present, commercial banks in India play a crucial role in integrating gold with the financial sector. However, this role is restricted largely to import of gold and a handful of government run schemes. The reason for such apathy towards the gold business is largely because banks do not consider the business of gold to be a part of banking business. In a country where more than 98 per cent of the gold consumed is met through import, the belittling of the gold business by the most trusted financial entities not only encourages the dominance of the grey market but also creates distrust among global market participants. Under such circumstances, our country stands nowhere when it comes to influencing global bullion prices. On the other hand, our next door neighbour and closest competitor, China, has already made inroads into the global bullion market. A few years ago, the Industrial and Commercial Bank of China (ICBC) became one of the market making members of the age old LBMA benchmarking. It is well-known that the LBMA is majorly responsible for determining gold prices on a daily basis and is followed by a majority of the global bullion market. Not only this, China has in fact gone a step further to establish its own gold benchmarking known as the Shanghai Gold Benchmark, modelling it on the existing LBMA model. This now gives market participants an alternative price fixing mechanism in a different currency, ending LBMA’s monopoly in the gold price determination.

India must aspire to become a price influencer instead of a mere price taker in the global bullion market. However, the pre-requisite for this is to develop its domestic bullion market, which is

currently an unregulated entity. The absence of a transparent price discovery mechanism, lack of standardisation in the quality of gold and the lack of a transparent market for trading are a few of the major challenges impeding India’s ability to be a price influencer.

A dedicated entity such as a bullion bank can address these problems. Bullion banking is a well-established concept among developed economies and has been in existence in both Europe and the Americas for a long time. Gradually, this concept is being picked up by Asian countries now with ICBC being a recent example. Most bullion banks are diversified business arms of larger commercial and investment banks specialising in the commodities business, more specifically in precious metals. Although the functions of bullion banks are varied, these are typically engaged in the business of precious metals through market trading, clearing, vaulting, distribution through leasing and sale, acting as an agent between lender and borrower, mine financing and hedging, and generating research data on precious metal market among other activities. Bullion banks function in a manner similar to commercial banking while treating bullion the same way as commercial banks treat cash. Globally, almost all bullion banks maintain a membership with the LBMA and its sister concern, the London Platinum and Palladium Market (LPPM).

In India, bullion banking is yet to become an established concept as banks do not consider bullion to be their mainstay business. By contrast, most Indian banks have traditionally been averse to dealing in gold based products, as reflected in the

5. Bullion Banking in India


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erstwhile Gold Deposit Scheme, Gold (Metal) Loan (GML) or the recently launched Gold Monetisation Scheme (GMS). Even a risk free product such as the Indian Gold Coin (IGC) finds only a handful of takers among the banking fraternity. So what makes the banking community look down on the business of gold? A mix of both commercial and regulatory challenges probably is the main reason for the apathy displayed by banks. On the commercial side, banks claim that the gold industry is largely an unorganised sector in India with easy access to grey market gold. Goldsmiths have been the traditional dealers of gold in this country. Commercial banks dealing in gold face stiff competition from the unorganised gold jewellery sector, which in turn affects their primary banking business. Under such circumstances, banks feel that the business of gold is best left to the jewellery industry. On the regulatory side, there are several regulatory challenges that banks dealing in gold face. First, neither The Banking Regulation Act of 1949 nor The Reserve Bank of India Act of 1934 provides a clear definition of bullion or gold per se. Hence, it becomes a challenge whether to treat gold as a currency or a commodity. Second, there are multiple regulators involved in the business of gold. While RBI regulates banks dealing with gold, the import of gold is governed by the Director General of Foreign Trade (DGFT). Similarly, SEBI oversees the trade of gold on exchanges, while the Bureau of Indian Standards (under Department of Consumer Affairs) verifies the quality of gold. The agony of dealing and co-ordinating with assorted regulators at the same time make most banks averse to participating in the gold business. Despite these predicaments, if a bank does take up the gold business, hedging price risk becomes a dilemma as RBI does not allow banks to participate on domestic commodity exchanges (except for GMS). Furthermore, banks

that collect gold through schemes like GMS lack suitable avenues for deploying the gold, making gold a dead asset. Hence, most banks prefer to skip dealing in gold.

However, with RBI’s commitment to issuing differentiated banking licences, it is the perfect opportunity to create a niche banking set up for the specific purpose of dealing in bullion. With a business focused on bullion, a bullion bank can be a ‘one-stop’ institution responsible for undertaking lending and borrowing of gold; installing a vaulting mechanism, lending logistical support to gold distribution and helping as a repository of bullion related data and information. A bullion bank will also take care of the twin problems of standardisation and price discovery in the domestic market. Most importantly, introduction of a bullion bank will provide the much needed push to the gold monetisation programme. The bullion bank can get into gold-rupee swaps with commercial banks for GMS, while commercial banks work as collection centres without worrying about the end use of the collected gold. Besides, a bullion banks will have the necessary expertise to buy back gold providing an alternative option to retail customers for selling gold. This will bring back a large part of the physical gold held as investment back to the financial system. Subsequently, the gold collected through GMS and buy-backs can be recycled to be used for the purpose of GML, thus easing the burden on import. Alternately, they can be also used for minting IGC. The bullion bank will further encourage young investors to move to innovative gold backed investment products such as gold savings accounts, gold exchange traded funds (ETFs) and gold bonds rather than investment in physical gold. A bullion bank will also play an important role in the global bullion market. With

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RBI willing to provide differentiated regulatory advantages to niche sector specific banks, the bullion bank will be able to participate in both the global and domestic spot and derivative markets. This will open the doors to major global markets such as London Bullion Market for OTC trade and major derivative exchanges around the world. Provided the right kind of initiative is undertaken, India can have its own bullion bank participating in the global price discovery mechanism, such as the LBMA benchmarking and the Shanghai

benchmarking. Going by India’s gold consumption pattern, the country should have been a global price setter long ago. Hence it is in the greater interest of the country that bullion banking should be considered as a mainstay commercial business and looked separately from the commercial banking business. Setting up of bullion banks in India will not only help in strengthening the gold eco system but will also be a first step to consolidate the huge unorganised jewellery sector in the country.

Chapter 6:Gold Vaulting in India

Key Points

■ In India, bullion vaulting at a nascent stage

■ Bullion vaults in India are unregulated entities

■ WDRAI is responsible for the development and regulation of the

warehousing business

■ Currently, WDRAI regulates only warehouses for storage of agricultural

commodities

■ WDRAI should extend its regulatory outreach to gold warehouses

(vaults)

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To achieve a robust gold ecosystem in India, one of the pre-requisites will be to develop a rigid storage and logistical framework for gold in the country. Warehousing of gold and precious metals, also known as vaulting, is the mainstay of a robust financial and business bullion ecosystem. The need for a regulated vaulting mechanism can be gauged by the fact that the leading countries in bullion business today have all developed and maintain a very high standard of vaulting infrastructure. A regulated and efficient vaulting system will not only promote transparency in dealing but also better distribution of quality gold in the country.

In India, bullion vaulting is still at a nascent stage. In the current scenario, bullion vaults in India are largely unregulated entities. Recently, SEBI has directed the commodity derivatives exchanges trading in bullion to register vaults used by them and adhere to basic vaulting guidelines. The commodity exchanges have been further directed to undertake periodic checks to ensure that these vaults are following the laid out guidelines. Although this is a smart move by SEBI to ensure standards in vaulting in the absence of a real regulatory authority and rigid compliance mechanism, these frameworks are only ‘second best’ alternatives in comparison to international vaulting standards. Moreover, this surrogate regulatory system extends only up to vaults under exchanges but fails to govern those used by banks, bullion depositing NBFCs, asset management companies and other FIs dealing in bullion.

The last decades saw several reforms being carried out in the warehousing and storage infrastructure in India. One of the most important steps perhaps was the setting up of the Warehouse Development Authority of India (WDRAI) in 2010 under the Warehouse (Development and Regulation) Act, 2007, vide GoI Gazette Notification dated October 26, 2010. WDRAI is responsible for the development and regulation of the warehousing business, to ensure the negotiability of warehouse receipts and to promote the orderly growth of the warehousing business in the country. Currently, WDRAI regulates only warehouses for storage of agricultural commodities and has notified a total of 149 agricultural and horticultural commodities for issuance of Negotiable Warehouse Receipts (NWRs).

To create a transparent and efficient gold distribution network in India, it is essential that bullion vaults in India are regulated and stringent guidelines are laid down to ensure that only good delivery gold is stored and distributed in the country. A regulated gold vaulting system will also help create and maintain account of allocated gold in the country. Further, this will help in creating a new product, i.e., trading of NWR on exchanges. To ensure this, WDRAI should extend its regulatory outreach to warehouses (vaults) storing gold and other precious metals. Apart from that, regulation of vaults by WDRAI will also encourage private bullion vaults to get into formal bullion vaulting business in the country.

6. Gold Vaulting in India

Chapter 7:Recommendations

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7.1 Regulatory Guidelines■ A separate regulatory entity under a statutory

Act must be created to regulate procurement, distribution and trade in gold.

■ Gold (under precious metals) should be carved out from non-agricultural commodities and should be defined. Currently, gold is not defined anywhere and is used as a commodity, currency and security as per the discretion of the user.

■ The government should allow the setting up separate bullion banks with special expertise in dealing in precious metals. These banks can be set up under the differentiated banking licence of RBI. Bullion banks in India should be created on the lines of global bullion banks such as ScotiaMocatta, BNP Paribas SA, ICBC, and Merrill Lynch International etc.

■ The Warehouse Development Regulatory Authority of India (WDRAI) should notify gold as a commodity for vault accreditation. Currently, WDRAI regulates warehouses used for storing agricultural and horticultural commodities, which are stipulated by the DCA. WDRAI should be allowed to accredit vaults for all precious metals.

7.2 Revamped – Gold Deposit Schemes (R-GDS)■ The focus of GMS should be to attract retail

participants. Banks should be allowed to accept gold coins in tamper proof packaging such as IGC and Suisse gold coins earlier sold by banks by bypassing the CPTC route.

■ The deposit amount for GMS should be as low as 1g.

■ Banks should also be allowed to accept vaulted gold under GMS.

■ NBFCs should be allowed to act as collection points for GMS.

■ Instead of forcing banks to lend gold under GML, the end use of GMS gold should be left to their discretion.

■ Role of CPTCs should be re-examined.

■ Financial audits and credit rating of CPTCs must be conducted before granting CPTC licence.

■ Refiners should be encouraged to tie up with CPTCs.

■ CPTCs should be also allowed to facilitate opening of gold deposit account on behalf of partnering bank.

7.3 Gold Metal Loan (GML)■ GML must be incentivised over outright

purchase for both banks and jewellers.

■ GML should be categorised under priority sector lending (PSL).

■ The tenure of GML should be flexible and should be left to banks to decide, based on their existing relationship with jewellers.

■ Bank should be allowed to source gold from the domestic market, not only for the purpose of GMS and rather should be allowed for all purposes.

7.4 Trade on Exchange■ Bullion should be moved from State List (List II)

to Union List (List I).

■ A bullion spot exchange must be set up under Ministry of Finance (MoF), Ministry of

7. Recommendations


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Commerce (MoC) or Securities Exchange Board of India (SEBI). Further, it must be created under a Statutory Act with appropriate functioning guidelines.

■ Banks must be allowed to participate in commodity exchanges, at least for gold and other precious metals and not just for the purpose of GMS.

■ Vault infrastructure must be developed to support exchange.

■ Refiners and jewellers must be encouraged and incentivised to trade on exchanges.

■ CTT on gold futures must be removed.

■ Trading of NWRs for gold should be introduced in India for trading on commodity derivatives exchanges.

7.5 New Gold Products

■ Product innovation around gold is a must – insurance, pension, mutual funds and banks must innovate.

■ Innovations must be market driven. The government should become a mere facilitator.

■ Enabling regulations and clarifications must be provided to allow for gold based and gold backed innovative products.

■ Tax breaks such as exempt-exempt-exempt (EEE) status must be considered to gather greater retail participation in SGB. This will attract fresh funds.

■ Gold Exchange Traded Funds must either be given equity linked savings scheme (ELSS) status or taxed as equity to encourage people to invest in capital market gold products rather than physical gold.

7.6 Gold Swaps and Inter Bank Lending

■ Gold swaps will help increase volumes for GMS.

■ Since banks have limited options for gold collected under GMS, different swap products must be considered for the utilisation of the collected gold, such as:

a. Gold rupee swaps between banks

b. Gold rupee swaps between banks and NBFCs

c. Gold rupee swaps between RBI and banks

d. Gold and dollar swaps by government, banks and RBI

■ The gold swap market in India will need greater detailing and understanding.

7.7 Marketing Strategies

■ We must co-opt NBFCs into GMS, at least NBFCs which provide gold loans and take gold deposits.

■ Small banks and payment banks must also be allowed to participate in GMS. The India Post has tremendous reach across the country.

■ The IGC must be made easily available across more cities and centres, including all banks, jewellers and NBFCs.

■ SGB must be sold through all types of institutions and not just financial institutions, much like how ‘Kisan Vikas Patra’ was marketed.

■ India could consider developing a market for standardised jewellery, both 22k and 18k, since the demand for both is fairly high.

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Unravelling the Constraints

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