Central Bank’s gold loan LTV cap sparks industry concerns

For many, gold loans remain the only accessible form of credit. Restricting LTV ratios now risks stifling entrepreneurship, discouraging investment in small and medium enterprises, and undermining financial institutions’ profitability, given their reliance on gold loan interest income

Are Loan Sharks the beneficiaries?

The Central Bank of Sri Lanka’s newly imposed Direction No. 2 of 2026 on gold-backed lending has stirred significant debate across the financial sector and wider society. The directive, which mandates a maximum Loan-to-Value (LTV) ratio of 70% for gold loans and pawning facilities offered by banks and licensed finance companies (LFCs), aims to strengthen prudential risk management. Yet, industry stakeholders warn that the measure is creating unintended hardships for households, entrepreneurs, and the jewellery trade.  

Gold as lifeline  

Gold has long been regarded as Sri Lanka’s most liquid asset after cash. Beyond its cultural and sentimental value—particularly among Tamil communities where gold jewellery is deeply tied to tradition—it serves as a critical financial buffer. Families routinely pledge jewellery to meet short-term cash needs, ranging from household expenses and medical emergencies to small business funding, agriculture, construction, tourism ventures, and working capital requirements.  

Industry data highlights the scale of reliance on gold-backed credit: 

• Over 60% of household gold jewellery is believed to be pledged under gold loan/ pawning facilities.  
• Licensed finance companies maintain gold loan portfolios exceeding Rs. 500 billion as of 31 March 2026, with annual growth of Rs. 150 billion compared to the previous year.  
• More than 50% of loans are granted for consumption purposes.  
• Approximately 60% of gold loan facilities are short-term loans with maturities of one to three months.  
• Banks have increasingly introduced short-term gold loan products to compete with LFCs.  
• During recent periods of rising gold prices, institutions granted facilities at 80–90% LTV ratios, far above the new 70% cap.  

Mounting pressures  

The new 70% cap has disrupted this ecosystem. Customers who previously borrowed at higher ratios now face difficulties renewing short-term loans without making substantial capital repayments, often Rs. 40,000–50,000 per sovereign. Many borrowers, though able to service interest, lack the liquidity for sudden principal payments.  

Consequences include:  

• Rising non-performing loan (NPL) ratios across the sector.  
• Monthly auction values of pledged jewelry nearing Rs. 3 billion, up In LFC s sharply from previous months.  
• A negative growth of Rs. 4 billion in LFC gold loan portfolios last month alone.  

This trend risks eroding family assets of deep sentimental value, such as wedding jewellery and heirlooms. In desperation, borrowers are turning to informal moneylenders and microfinance providers charging exorbitant rates of up to 50% per annum, further compounding social and financial distress.  

Informal lending surge - loan sharks

In the current economic environment, many banks and licensed finance companies are either unwilling or unable to provide timely gold-backed lending facilities to customers in need of urgent liquidity. As a result, thousands of people, driven by financial desperation, are forced to turn to informal moneylenders who charge interest rates as high as 10% per month—equivalent to 120% per annum.  

Most borrowers approach these lenders believing the loan will be temporary. However, the combination of exceptionally high interest and continuing financial difficulties often makes it impossible to redeem their pledged gold. Over time, they lose valuable family assets accumulated over generations.  

The principal beneficiary of this situation is the informal moneylenders and used gold buyers who profits not only from excessive interest but, in many instances, ultimately acquires the pledged gold itself. This raises an important public policy question: Is this the outcome that the State intends? 

Wider economic impact  

The timing of the directive has amplified its effects. Over the past four years, Sri Lankan households and SMEs have endured successive shocks:  

• Easter Sunday attacks  
• The COVID-19 pandemic  
• Fuel and energy crises  
• Sovereign debt crisis  
• Natural disasters  

For many, gold loans remain the only accessible form of credit. Restricting LTV ratios now risks stifling entrepreneurship, discouraging investment in small and medium enterprises, and undermining financial institutions’ profitability, given their reliance on gold loan interest income.  

The jewellery industry too faces headwinds, with declining demand for gold investments and valuation disputes arising from disparities between official and market prices.  

While the Central Bank’s objective of mitigating systemic risk is widely acknowledged, critics argue that the current approach risks destabilising households and industries that depend on gold-backed credit. The challenge lies in striking a balance between financial stability and preserving access to a centuries-old lifeline for Sri Lankan families and businesses

Policy recommendations on gold-backed lending

Industry stakeholders are urging regulators to recalibrate the proposed policy framework governing gold-backed lending to ensure that it protects consumers while preserving access to formal credit.

The following measures are recommended:

1. Remove the proposed 70% Loan-to-Value (LTV) cap and revert to the previous framework, under which licensed banks and finance companies were permitted to make their own commercial decisions based on their individual risk assessments and credit policies.

2. Recognise the industry’s proven risk management record. For more than two years, licensed finance companies and banks have generated substantial business through gold-backed lending while managing the associated risks effectively. Institutions should therefore be allowed to determine their own lending limits, subject to prudent regulatory oversight, rather than being constrained by a uniform LTV cap.

3. Address the unintended consequences of restrictive regulation. Excessively restrictive LTV limits are likely to drive borrowers away from the regulated financial sector and into the hands of informal moneylenders and loan sharks, who often charge interest rates as high as 10% per month or more. This undermines consumer protection and increases the risk of borrowers losing their pledged gold.

4. Strengthen regulation of the informal lending sector. Greater regulatory attention should be directed towards unlicensed moneylenders who charge exorbitant interest rates and operate outside the formal financial system, rather than imposing additional restrictions on licensed and regulated financial institutions.

5. Review the valuation methodology for gold. The disparity between the gold prices recognised by the Central Bank for lending purposes and prevailing market prices should be addressed. A more market-responsive valuation framework would enable licensed institutions to provide fairer financing while maintaining prudent risk management.

The regulatory framework should strike an appropriate balance between financial stability, consumer protection, and continued access to credit. Policies that inadvertently reduce lending by licensed institutions may simply shift borrowers to the informal sector, where they face significantly higher costs and fewer legal protections.

Balancing prudence and access  

If the objective of public policy is to protect vulnerable citizens while promoting financial inclusion, then greater attention must be given to ensuring that licensed banks and finance companies are able to provide accessible, affordable, and efficient gold loan facilities. Strengthening the formal financial sector’s capacity to meet this demand would reduce dependence on exploitative informal lending, protect household assets, and support broader economic stability.  

While the Central Bank’s objective of mitigating systemic risk is widely acknowledged, critics argue that the current approach risks destabilising households and industries that depend on gold-backed credit. The challenge lies in striking a balance between financial stability and preserving access to a centuries-old lifeline for Sri Lankan families and businesses.  

(The author is a former Director General of the Securities and Exchange Commission of Sri Lanka,  a Senior Adviser to the Ministry of Finance and current Chairman of PMF Finance PLC)