Bharat’s Golden Opportunity – An Alternative for the Bank Capitalization Problem

This article proposes to discuss at length on the gold monetization scheme and suggest the measures to make it more effective. Nearly two years after it was first launched, the gold monetization scheme is yet to find many takers. The scheme could hardly attract deposits worth only 6,410 kg of gold since it was launched, less than 2% of the annual imports of the yellow metal in 2016.

According to various sources, the government is aiming at Rs. 5,000 crore from all the schemes — sovereign gold bond, gold monetisation and Indian gold coin — in 2017-18, compared with the budgeted level of Rs. 10,000 crore for 2016-17. The government’s estimates for 2017-18 are almost 50% down from the budgeted level for 2016-17 and it indicates poor response by the people to these schemes.

Bharatiya government has three schemes 1. Gold coins and bullion scheme 2. Sovereign gold bond scheme, and 3. Gold monetization scheme. While the first scheme is meant for people who desire to purchase gold (coins), the second scheme is to encourage people to invest in bonds that are linked to gold, whereas the 3rd scheme is aimed at (i) Mobilizing the gold held by households and institutions in the country, (ii) Sourcing the gold procurement of the Gems and jewellery industry  from domestic channels  (iii) Reducing import of gold (which is the second major import of Bharat after crude).

Salient features of Gold monetization scheme

This scheme replaces the gold deposit scheme, 1999 which has not been very successful. The deposits held under the Gold Deposit Scheme will be allowed to run till maturity unless the depositors prematurely withdraw them. Under this new scheme, the minimum deposit at any one time shall be raw gold (bars, coins, jewellery excluding stones and other metals) equivalent to 30 grams of gold (under the hitherto gold deposit scheme the minimum deposit was 500 grams of gold). There is no maximum limit for deposit under the scheme.

People can deposit their gold under this scheme even in the form of jewellery which will be melted and converted into bars. The purity of the gold will be assessed and accordingly a certificate will be issued to the depositor. The depositor can buy the certificate for a short term of 1-3 years directly from the banks and certificates issued by banks on behalf of the government for a medium term of 5- 7 years or even a long term of 7-12 years. The interest rate for short term deposit will be determined by the banks.

The deposit issued by the government will carry an interest of 2.25% per annum for medium term and 2.5% per annum for long term (it was 1 % in the earlier scheme). On maturity the deposit holder can get the gold or cash. The interest on these certificates is exempted from income, wealth or capital gains taxes. Premature withdrawal is permitted subject to a minimum lock-in period and penalty to be determined by individual banks for the short term bank deposit and by the government for medium term and long term deposits.

These options were expected to be more attractive and provide greater flexibility, thereby garner large quantum of gold under this scheme for monetization.

Resident Bharatiyas (Individuals, HUF, Trusts including Mutual Funds/Exchange Traded Funds registered under SEBI Regulations and Companies) can make deposits under the scheme. Major chunk of Bharat’s estimated 24,000 tonnes of gold (worth $800 billion i.e., 40% of GDP) is with HNIs and religious organizations/ temples, and this scheme was expected to target these segments. It is noteworthy that Bharat’s official gold reserves held by RBI are only 557.77 tonnes !!!

Utilisation of Gold mobilised under Gold Monetisation Scheme (GMS)

The designated banks may sell or lend the gold accepted under STBD (Short Term Bank Deposits) to MMTC for minting India Gold Coins (IGC) and to jewellers, or sell it to other designated banks participating in GMS. The gold deposited under MLTGD (Medium/ Long Term Gold Deposits) will be auctioned by MMTC or any other agency authorised by the Central Government and the sale proceeds credited to the Central Government’s account with the Reserve Bank. The entities participating in the auction may include the Reserve Bank, MMTC, banks and any other entities notified by the Central Government.

However, as this scheme covers raw gold (bars, coins, jewellery excluding stones and other metals) which will be melted and converted into bars, most of the HNIs and religious organizations/temples did not opt for this scheme as this will result in losing the identity of their gold jewellery/ ornaments.

Suggestions to introduce Derivative Rupee Gold Bond Scheme

An attractive gold bond scheme can be introduced to induce the people to deposit their gold with the banks under trust receipts/safe custody with the option of maturity payment in either gold or equivalent cash. To make this gold bond scheme flexible and popular people may be permitted to withdraw their gold ornaments on special occasions and redeposit once the occasions are over. These trust receipts/safe custody could contain a clause authorizing banks to raise funds against the gold deposited so that a derivative financial instrument can be floated by the banks backed by gold held with them under trust receipts/safe custody.

As a consideration for the people authorizing the bank to raise funds against the gold so deposited, the bank could even pay some fee on these trust receipts/safe custody and waive the rent on the gold so deposited under such trust receipts/safe custody.  Government could give a counter guarantee (comfort of repayment) to these derivative financial instruments and develop active primary and secondary markets for these derivative financial instruments by encouraging players from Bharat and abroad.

The funds so mobilized could be used by banks for long term infrastructure projects of national importance for both EPC (Engineering, Procurement and Construction) and PPP (Public Private Partnership) models. Redemption of these bonds to be made by the banks from the repayments of these infrastructure project loans by the contractors on receipt of the funds from government on completion of the projects under EPC models or out of the funds generated through toll/ fee collections under PPP ventures.

The following steps form part of the proposed Derivative Rupee Gold Bond Scheme:

  1. Customer deposits gold in bank under trust receipt/safe custody by giving the full details of gold so deposited.
  2. After due verification and valuation of the gold so deposited the bank gives a trust receipt/safe custody receipt to the customer.
  3. Customer has the option to withdraw the gold as per his requirements and again redeposit the same with the bank (like in the case of a locker.)
  4. Additionally the customer gives a consent to the bank (which will be part of the terms and conditions of the trust receipt/safe custody) authorizing the bank to mortgage his gold to raise funds.
  5. As a consideration of the customer giving authorization to the bank as above, the bank may pay bi-annual fee (say 1%) to the customer and waive the rental fees for depositing gold under trust receipt/safe custody of gold.
  6. Based on the customer’s consent, as above, the bank in turn issues a derivative rupee financial instrument/bond (which is backed by the gold for the face value of the bond) for a tenor of 5 years, 10 years and 15 years to raise funds. These bonds will be co-accepted/ counter guaranteed by government.
  7. This derivative rupee gold bond may be issued for a minimum of Rs. 5 lakhs and in multiples thereof fully backed by gold.
  8. Primary and secondary markets can be developed for these derivative rupee gold bonds by encouraging financial institutions and other notified eligible entities from Bharat and abroad to invest in the same. The interest rate for the primary issue of these bonds may be fixed at slightly higher than the interest rates of government bonds for the respective tenors (i.e., 5 years, 10 years and 15 years).
  9.  Operational mechanism- In order to ensure that at all points of time during the tenure of this derivative rupee gold bond the gold held with the banks fully covers the face value of the bond, the banks may restrict the issue value of these bonds to say 30%-40% of the gold  holdings held with them. This will also have to take care of additional quantum of gold required due to (i) the market price fluctuations of gold since at any point of time the issue price of derivative gold bond has to be fully backed by gold; as well as (ii) the short fall in the quantum of gold held by the banks due to temporary withdrawal of the gold deposited by the clients as permitted by the terms of the trust receipt/safe custody contract.
  10. Usage of the funds mobilized through derivative gold bonds- The banks will lend these funds to long term infrastructure projects, giving priority to PPP projects that are of longer tenor and of national importance.
  11. RBI to consider giving preferential treatment to these funds raised by the banks through derivative rupee gold bond with regard to SLR and give full exemption of CRR. The funds so raised by the banks may be treated as tier II capital so that the public sector banks can acquire additional capital which is the need of the hour and it will give some respite to the central government and reduce its burden on infusion of additional capital to these PSBs.
  12. Government and RBI may even think of floating a separate subsidiary to handle this total mechanism as a custodial entity and the banks may act as its agent to take care of the operational aspects.

Benefits of the proposed derivative rupee bond scheme

The above mechanism suggested will provide the benefits of (i) retaining the gold jewellery/ornaments intact in their original form avoiding the process of melting of gold and converting into gold bars; and (ii) withdrawing the gold jewellery/ ornaments for special occasions like marriages and other functions once in a while from the bank like in the case of lockers. These twin benefits will give the option to “have a cake and eat it as well” to the depositors of gold with banks.

Therefore, this suggestion may attract more gold investment into the system towards monetization than the currently proposed sovereign gold bond scheme, particularly for longer tenure. It goes without saying that offering attractive interest rates for these derivative gold bonds and encouraging secondary markets for active trading of these bonds are vital to the success of this scheme.

Religious institutions like temples etc., and HNIs could be the potential depositors of gold for this proposed modified scheme of gold monetization since the gold deposited by them will not be melted unlike the existing scheme. This gold backed rupee derivative bond co-accepted/counter guaranteed by the Government of Bharat will certainly attract investors from Bharat and abroad compared to clean bonds and this could perhaps be the first such innovative instrument in the global financial markets.


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About the Author

B.N.V. Parthasarathi
Ex Senior Banker, Management and Financial Consultant, Visiting faculty at premier B Schools and Universities. E mail- [email protected]