The co-lending model, introduced by the Reserve Bank Of India (RBI) in 2018, is a mechanism where banks and non-banks join hands to provide credit to the priority sector.
The co-lending arrangement allows NBFCs (Non-Bank Financial Companies) which operate in deeper geographies and lend to the MSME Sector (Micro, Small and Medium Enterprises), LIG (Low-Income Group) and the EWS (Economically Weaker Sections) categories, to access low-cost funds from banks.
Banks usually shy from lending to these groups due to high operation costs and credit risk.
The coming together of banks and NBFCs is a synergetic relationship that benefits both the parties and the borrowers. Let us explore the advantages of Co-lending and how it can create a vibrant financial ecosystem.
Co-Lending: An Overview
Co-lending, also known as co-origination, occurs when two lenders get into an arrangement to disburse loans jointly. Under this arrangement, the bank and the NBFC share the risk in an 80:20 ratio. Also, the customers, banks and NBFCs enter a tripartite agreement, and the NBFCs act as the single point of contact for the customers.
The RBI developed co-lending guidelines in 2018 that allowed banks and NBFCs to co-originate loans. These guidelines were amended in 2020 and are now known as Co-Lending Models (CML). The modified guidelines included Housing Finance Companies (HFCs), also in the framework apart from making other changes in the original policy framework.
Many banks and NBFCs are looking at enhancing the co-lending tie-ups in current times, especially when many NBFCs are struggling against the liquidity crunch. Co-origination gives the banks a chance to claim priority sector status for their share of the credit.
The co-lending model will likely touch a total volume of over Rs 30,000 crore by the end of FY 2022-23.
What Are the Benefits of Co-lending for All the Stakeholders?
The CLM offers benefits to all stakeholders of the credit ecosystem by empowering them on multiple fronts. NBFCs and HFCs can leverage their robust presence, while commercial banks offer synergy through the availability of funds for loan disbursal.
Let us delve deeper into this topic.
Benefits for Banks and NBFCs
- Better Risk Management
NBFCs are in a position to manage and spot risk much better compared to large banks. NBFCs and HFCs are more adept at assessing the creditworthiness of niche customer segments, which are usually not the core target group of banks. With a more structured approach, local focus and specialised skill set, they can evaluate credit applications better and reduce the risk exposure for themselves and banks.
A modern Loan Management System can help tackle challenges like proportionate sharing of risks and rewards, especially when an NBFC has multiple co-lending partners.
- Increased Reach of the Lending Ecosystem
Co-origination is based on the symbiotic association between NBFCs and banks. Public Sector Banks (PSBs) in India have access to the most affordable source of funds in the economy, and banks release 80% of the credit, which reduces the overall cost of funds. NBFCs can benefit from this and offer loans to their customers at lower rates vis-a-vis their competitors.
PSBs stand to gain from a partnership with NBFCs and fintechs as it enhances their last-mile reach. Instead of a one NBFC one bank contract, co-lending can be imagined as an open digital marketplace in the future. The co-lending framework will enable smooth and faster credit flow to SMEs, with NBFCs acting as the last mile link.
- Efficiency In Operations
With the use of automation and decision-making tools, co-lending allows lenders to have higher margins by processing more applications and disbursing more loans in a shorter span. The deployment of Artificial intelligence can help FIs analyse customer patterns and predict default probability, helping them make faster and more data-backed decisions.
- Prevents Systemic Liability
Banks and NBFCs can manage capital efficiently and decrease their liability through co-lending. They can scale their operations by finding lending partners with a good product-market fit. To ensure no negative impact on the profit and loss statement, the on-balance sheet spread that is lesser than or at most equivalent to the off-balance sheet spread can prevent any negative impact on the profit and loss statement.
As co-lending is a collaboration between banks and NBFCs, both partners focus on increased compliance and maintain it, thus preventing system liability.
Advantages for Borrowers
- Easier Access To Funds
Co-lending allows NBFCs to act as a link between groups which traditionally do not have access to credit and banks by providing them with easy availability of loans. Small businesses and people in the remotest part of the country can get a loan quickly with the help of a mobile application. Fintech has also made manual loan processing redundant through the partnership between prominent banks and NBFCs.
- Lower Rates
Low cost of funds, automation of the loan process, and established network of NBFCs help lenders reduce their cost of operation. They pass on this benefit to the borrowers through lower interest rates. The co-lending model allows grassroots-level borrowers to get credit at affordable and competitive rates.
- Financial Inclusion
Co-lending focuses on providing credit to the underserved and unserved groups of the economy. Leveraging the co-lending model, the low cost of funds from the banks and the broader reach of NBFCs allows people usually ignored by banks, mainly due to disparities in their credit risk management approach and core target segment.
Typically, banks take a cautious approach when lending to some sectors to avoid the risk of systemic liability. Partnering with NBFCs allows them to lend to the priority sector while keeping their risk levels in check.
NBFCs can capture a larger market share and process more loans which pump more credit into the economy.
The co-lending model offers a win-win for borrowers, NBFCs and banks. Borrowers get loans at lower rates than they would have gotten on a standalone basis from the NBFC. They also get a steady flow of dependable and economic sources of funding, and banks benefit from better deployment of their funds that reach the last mile.
Therefore, co-lending is a suitable way forward. If executed well, the process can benefit the economy as a whole. Finezza offers a suite of customised solutions to optimise co-lending and other financial operations to enable organisations to tackle credit and lending challenges, technology integration, and ground-level executions. For example, we help banks, NBFCs, and other lenders track and manage credit applications, process KYC documents faster, assess lending risks, and streamline the entire lending process.
Talk to our experts to know more!