Co-Lending Model (CLM) is still in its infancy in India. RBI devised this specific lending model to improve credit availability to the underserved and unserved categories of the economy.
Generally, these segments are isolated from mainstream banking facilities due to their geographical or demographical characteristics. They include low and medium-income categories, Micro, Small, and Medium enterprises (MSME), economically weaker sections (EWS), etc.
While the Reserve Bank of India (RBI) first issued guidelines on the co-origination of loans in 2018, the pandemic-related credit crisis created greater significance and momentum for the model. Gradually, an increasing number of Non-banking Financial Companies (NBFCs) and banks are entering into co-lending arrangements.
The co-lending market is expected to achieve a volume of Rs.25,000- Rs.30,000 crore in FY 2022-2023. One can conclude that co-lending is ready for take-off with NBFCs and banks planning to issue Rs.50,000 crore credit, as stated by the kingpins of NBFC firms in a recent Banking, Financial Services, and Insurance (BFSI) summit.
6 Factors That Would Spur The Growth of Co-lending
The co-lending model intends to make affordable credit available to the economy’s priority sectors. The framework makes use of banks’ surplus funds and NBFCs’ outreach to provide low-cost loans to borrowers. This tripartite arrangement benefits all parties involved-the bank, the NBFC, and the debtor.
Let us delve into some key factors that will drive the co-lending growth in the coming days.
1. Continued demand for credit in the economy
In terms of credit, it is the supply rather than the demand which has been a challenge. Economic Survey 2022-2023 forecasts increasing demand for bank credit for the next fiscal year. The current year has seen a revival of economic activity, which is supported by a fundamentally stronger banking system and a robust corporate sector.
Non-food bank credit increased by 15.3% on a year-on-year basis in December 2022. This credit growth is visible across sectors like home loans, agriculture and allied activity loans, and MSMEs which are driving industrial credit.
The survey also predicts an active rise in credit in FY2024 if inflation declines and the real cost of borrowing does not increase.
In the co-origination model of lending, the benefit of low-cost capital trickles down to the borrower keeping the interest rate in check. Effectively, there will be more takers for such loans.
2. Increased government spending on infrastructure
Infrastructure spending often creates a bigger economic stimulus than other types of spending. Capital expenditure on infrastructure generates a multiplier effect on other sectors like real estate, cement, steel, and transportation.
Also, Infrastructure development projects provide NBFCs with lending opportunities in direct lending or equipment financing through co-lending.
3. The pressure of Priority Sector Lending (PSL) targets on banks
If a bank fails to meet its PSL targets for the year, it must invest the lending shortfall amount in Rural Infrastructure Development Funds (RIDF). They can also purchase excess PSL certificates from banks that have exceeded their lending target for the priority sector.
In this case, co-lending partnerships with recognised NBFCs will assist banks in meeting the PSL targets.
4. Regulatory modifications by the RBI
The RBI has made significant regulatory changes affecting NBFCs and fintech lending in the last two years. The scale-based lending framework for NBFCs focuses on strengthening the NBFCs’ governance, capital adequacy, and technological infrastructure.
RBI’s new digital lending guidelines aim for transparency and efficiency in fintech lending. These regulatory changes reinforce the fundamentals of the co-lending model.
5. The Untapped credit market in tier-2 and tier-3 cities
Tier-2 and tier-3 cities in India are quickly emerging as development hotspots. The most recent budget authorised the establishment of an Urban Infrastructure Development Fund (UIFD) of Rs.10,000 crore per year for the development of infrastructure in these cities.
Compared to traditional banks, NBFCs have a more substantial presence in tier 2 and tier 3 cities. Through co-lending partnerships, NBFCs can use this advantage to enter the untapped credit market in these geographies.
6. Reduced cost of funds for NBFCs
When the RBI tightens monetary policy, the cost of funds for NBFCs rises, making their loans more expensive for borrowers.
Co-lending enables NBFCs to obtain low-cost funds from banks for onward lending to customers.
Some Hurdles The Co-Lending Model Has to Overcome
The growth of co-lending poses some challenges to lenders as well. Understanding and overcoming those obstacles is critical for maintaining a sustainable business model.
1. Complex process model– Banks and NBFCs share risks and rewards in the co-lending model. Proportionate allocation of benefits and drawbacks necessitates complex accounting methodologies, complicating the lending model even further.
2. Banks unaware of their customers’ risk profiles– In a co-lending arrangement, NBFCs become the customer-facing entities engaged in sourcing, onboarding, and servicing the borrowers. Here, banks are unable to assess the risks posed by their borrowers. Hence NFBCs must improve their underwriting capabilities because they are responsible for maintaining the co-lending asset quality.
3. Different regulatory compliances for the lenders– Apart from general compliance procedures like Know Your Customer (KYC), other regulatory and compliance requirements for both lenders differ, making reporting difficult.
4. The demand-supply disparity in the PSL segment– When banks fall short of their priority sector lending targets, they rely on other banks and NBFCs to purchase PSL certificates or engage in Inter-bank Participation Certificates (IBPC) transactions. However, NBFCs’ exposure to priority sector loans is far lower than banks’ demand. PSL may not gain traction unless co-lending takes off.
5. Integration of loan management functions– Co-lending necessitates using an agile Loan Management System (LMS) capable of handling the nuances of NBFC-bank relationships. LMS must efficiently manage the various stages of the credit management process while shielding the customer from the troubles of the fragmented loan processes. It must also accurately deal with complex bookkeeping and reporting functions.
Co-lending is, undeniably, a long-term, scalable model. The challenge is to maintain the lender partnerships to continue leveraging the framework. Driven by credit demand and expedited by fintech tools’ support, the model has the potential to reach new heights of progress very soon,
Finezza’s Loan Management System is one such fintech tool ideal for co-lending firms seeking to grow their business. Our LMS’s embedded capabilities capitalise on the synergies of NBFCs and their banking partners.
Besides that, we also offer analytics and a suite of other specialised solutions that streamlines and automates critical business processes.
Contact us today to learn more about our LMS.