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14 responses to “How Can the State Bank of India Pay Interest in Gold?”

  1. Seems to me little different than buying paper gold. If you don’t hold physical, you don’t have anything except a paper promise.

    The only way I can think of offhand that this isn’t A) a bank possibly going bankrupt or B) sinister, is that the bank backs the gold with something else that’s real, i.e., land, such that if the price of gold (in dollars) rises higher than the interest the bank receives in investing the proceeds, the land is sold to make good the debt in gold.

    And you believe that, I have some gold paper contracts I’ll be happy to sell you at a 10 percent discount to physical market prices. :)

  2. Keith–I think the answer is that like all Central Banks or other government run banks, they plan to privatize the gains and socialize the losses.

  3. The classic answer is simple: if the gold was used to finance (say, as collateral) a productive investment yielding over 1%, everybody wins. The Temple gets its 1% and the State Bank gets anything over that. Conversion into currency need not be part of the equation.
    Being India, however, I suspect some sort of favor is going on.

  4. I think Sanctuary’s formula is about right. Whichever way the bank’s fortune cuts, the fact that the gold deposit is dedicated to a sacred cause covers them in any debate that may follow.

    But, at the risk of destroying some of the capital in your fine article, I can pile-on another speculation:

    The State Bank and the State’s tariff and import authorities could be in bed: plotting to de-stabilize the internal gold price and use their inside timing-information to shake down India’s gold traders.
    The fact that the promised return is so far above the usual lease rates suggests that the Temple understands and condones the plot – is not a victim. Just another guess.

    Let us know what you learn, Keith.

  5. I think the problem here is that we are equating dollars to gold. It is true that dollars can buy gold and gold can buy dollars but they are not the same. If the Temple loans gold and receives goad then the only risk is the default on the loan. The dollars are just background noise. A dollar after all, is just a debt. Gold is an asset. This is something like comparing apples and oranges.

    Another way to loan gold is to require repayment in oil. These are totally different assets, however. The benefit is that they both have actual value. The mechanics of this loan would be less complicated if dollars were ignored altogether.

    Holding dollars is like storing your water in a leaky bucket. [As Keith wrote, just look at the graph of the dollar over the last hundred years.] When you come back later examine the contents of your bucket, you notice that some of the water is gone from leaks and evaporation. How do you compare two assets when one of those assets is a moving target?

    My conclusion is, that loaning gold for gold make sense if you ignore the dollar and require repayment and the interest in gold. With this in mind can set an interest rate of f5, 10 or even 12%, etc.

    Another way to look at this is that it makes no more sense to loan gold and accept payment in dollars, than it does to loan gold and accept payment in stocks of TSLA. Tesla is an even faster moving target than dollars because it fluctuates so much up and down.

  6. From The China Gold Market Report 2008:

    Gold leasing business, also called ”lending gold and paying back in gold” business, is a service where commercial banks lend their gold holdings to other commercial banks or gold producers or manufacturers and charge interests as the leasing contract stipulates. The gold borrowers shall pay back the liability with physical gold when the contract expires. This business can be divided into inter-bank lending and corporate leasing classified by the leasing targets.

    Inter-bank lending means short-term gold leasing between commercial banks, where the borrower sells the leased gold on the market or use it to produce its proprietary brand of physical gold bars, and then purchases gold through the market to repay the lender upon expiry of the contract. Corporate leasing means that the gold producer sells the leased gold on the market for capital and pays gold produced by itself back to the commercial bank, or uses the leased gold in jewelry processing or other purposes and then purchases gold through the market using the sales income of jewelry to repay the lender upon expiry of the contract.

  7. Thanks for the great comments. Here is a quick thought:

    mongoose: There was always a choice to hoard one’s gold, earning nothing, or take the risk and lend it out to get a yield. JP Morgan once said something to the extent of “4% will bring the gold from the Continent [i.e. to NY], 5% will pull the gold off the moon.”

    The alternative, if no one lends, is total collapse of the economy.

  8. Dear Keith,

    The correct answer is that SBI lend the gold to the Indian Jewellers @ 4-5% interest and the interest is paid in terms of Gold itself. There is complete hedging and no need to go for exotic structuring. The timing of its giving back the Gold to the temple and receiving the gold given to the jeweller is same. In effect there is no future price riskl. In toto, they generate good 3-4% NIM in this scheme.

    Cheers,

  9. Yess this can be a win win situation for all and at the same time cad issues are taken care off. Which is the need of the hour in indian economy terms

  10. Hi Keith. This is quite a profound article you’ve written. I’ve normally thought about the holders of gold generating an income using a different mechanism (selling spot, buying a future on margin, and investing the cash difference). In the end the conclusions are the same. This only works if the dollar price of gold is stable or falling. If the price rises, which eventually it must, then capital is destroyed. If correct then this implies that compared to gold, owning debt is ALWAYS a speculation.

  11. Hi Keith,Couple of points -But before that, since this is India some serious 3rd party benefit, quid pro pro could be in place.
    Firstly ,couple of years ago read a news item about Belgian Govt gold deposits moved to a 3rd part account and the Govt had received an interest on it of 0.50 % per annum. Obviously this led to a din in the country. Could you please throw some more light on this

    Secondly, if the gold deposit is still in any of their Indian branch, SBI though paying in gold but the denomination for converting purpose would be in Rupee I presume.

    Thirdly-Ignoring all proprietory/legal issues –Assuming deposits are being maintained in Indian branches.SBI bank issues credit limit ( against the gold deposit of the Trust)in favour of some high powerd cients with the knowledge or otherwise of the Trust..Bank will easily earn 10-12 % per annum ( in rupees)for any loan advanced against these limits..Given the decay in gold prices and a mostly depressed Rupee ( against any major currency) in the past one year many who have taken small gold loans in India ( small traders /small business men /households )would be hard pressed to service their margin calls/ loans in lieu of falling prices and in addition to any distress that they may have suffered in their small business and have probably turned NPA..This is where SBI gets atleast some of the gold to pay the 1% interest ( albeit partly).For the balance part given the fall in prices it would be smart to buy the gold for interest payment from the market.

    My third point is certainly speculative and could have many flaws but what is your opinion in the light of making commercial sense of this arrangement in lieu of future gold prices, Rupee fluctuations etc?—your kind comments please.

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