Chinese banks are growing alarmed by a rising number of defaults among jewelry manufacturers, prompting them to review new lending more carefully in the world's biggest consumer, according to sources with direct knowledge of the issue.
The top four Chinese banks alone have up to 443.4 billion yuan ($69.63 billion) tied up in gold leasing, so any pull back could cut China's imports and hit global bullion prices that are already languishing at the lowest in more than five years.
Bank of China, the country's fourth-biggest lender by assets, has seen at least one default on a loan, said two sources familiar with the issue, who declined to be named as they were not authorized to speak to the media.
Other banks, from major players to smaller lenders, have also seen defaults by jewelry makers, said four sources.
The defaults are still only a small percentage of total gold loans but banks are already taking steps to slow the pace of such lending, the sources say.
"Banks are generally taking a more cautious approach to gold leasing," said Samson Li, senior analyst with GFMS, a metals consultancy owned by Thomson Reuters.
"If there is a massive default, they will significantly cut back on this business, and that will affect China's imports," he said.
Gold leasing has grown rapidly in the last few years, as tight credit conditions drove companies to look for alternative ways to raise money.
"What drives demand for gold leasing is not gold itself, but relatively cheaper loans," said Jiang Shu, chief analyst at Shandong Gold Group, the parent of Shandong Gold Mining.
Loans are typically offered to firms in the bullion industry, such as manufacturers, who use the gold to make jewelry, or bullion producers, who raise funds for their operations by selling the leased bullion.
Some manufacturers have also been acting as credit providers themselves, lending cash from the sale of the leased gold and pocketing the difference between gold and cash loan rates, say industry officials.
Those funds can end up being used for speculative investments such as real estate.
Retail gold sales down
With gold retail sales taking a hit due to a slowing Chinese economy and a bearish price outlook, manufacturers are finding it harder to repay the loans.
"Banks are looking at the risks, rather than the profits," said a source at a big state-owned bank, adding that demand for gold loans remained but banks had turned more cautious.
A jewelry manufacturer defaulted on a small loan taken out with Bank of China as recently as October, said a source, adding the bank now wanted to limit the amount of new leasing business.
Bank of China did not respond to repeated phone calls and an email seeking comment.
Among other big banks, Industrial and Commercial Bank of China did not reply to an email seeking comment on whether they had seen any defaults.
Precious metals holdings of the top four Chinese banks totaled 443.4 billion yuan as of Sept. 30, up more than 40 percent from 2013, according to their latest financial reports. Nearly all is likely tied up in gold financing and at current prices would amount to around 2,000 tonnes of bullion.
Bank of China saw a drop in its holdings in the latest quarter, although the reason was unclear. a private lender, also saw a decline.
But most other banks continue to increase gold assets, driving China's bullion imports at a time when consumer demand in the mainland is headed for a second annual decline.
Physical deliveries from the Shanghai Gold Exchange (SGE), the platform over which physical transactions, including leasing, takes place, are on track this year to beat the previous record set in 2013.
This indicates an active leasing market, since consumer demand has fallen.
"More jewelry companies are defaulting as the Chinese are not purchasing as much gold jewelry as before," said a source at another big bank.
Partly blaming weak sales, Chow Tai Fook Jewelry, China's top jeweler by market value, has warned its first-half net profit could drop by up to 50 percent.