Businesses need substantial working capital to maintain their cash flow, ensure smooth functioning, and boost profitability. With time, many small lenders have made a tremendous impact by availing credit to businesses in sectors such as small and medium enterprises (SMEs), agriculture and education.
This has also led to difficulty in getting capital for non-banks to fund their credit offerings to customers. This is effectively tackled by co-lending. This article will discuss how co-lending has impacted credit availability.
What is Co-Lending?
Co-lending is a setup where both banks and non-banking financial companies (NBFCs) enter a negotiation to jointly address the needs of customers with a risk and reward model throughout the life cycle of a loan. Mostly, the risk is in the ratio of 80:20 (80% for the bank and a minimum of 20% for the non-banks).
This helps in relying on each other’s strengths where non-banks would do the heavy lifting of loan origination and paperwork whereas banks would offer liquidity to finance most of the loan.
It is important to note that NBFCs play an important role in bridging the market gap and enabling underwriting loan applications of customers (including the unbanked) and decisioning insights.
RBI has established a framework for co-origination of loans, where banks and non-banks are jointly lending funds to the priority sector.
Some of the features of co-lending include:
- Seamless sharing of customer information between partners.
- Easy deployment on cloud.
- Comprehensive accounting along with paperless processes and real-time report generation.
- Maintenance of strict adherence to business policies of each partner.
- Ensure regulatory compliance to requisite reporting.
- Easy digitisation and automation.
How Does Co-lending Function?
To make co-lending work, both banks and NBFCs enter a tripartite agreement with businesses. This can happen in three steps:
Step 1: The non-bank initiates the loan-origination process with the assistance of co-lending software with proper and relevant documentation. Then it recommends them to the partner bank.
Step 2: The bank performs a requirement analysis and risk assessment of the customer and proceeds upon confirming they are credit worthy.
Step 3: The lenders reach a tripartite agreement with the customer. The bank and the non-bank pool their funds into an escrow account from which the loan shall be paid out.
While both lenders maintain the client’s accounts, they need to share information and work together to produce a unified account statement for the borrower to facilitate refunds.
Five Critical Benefits of Co-Lending in Easing Credit Availability
Here are the benefits of co-lending:
1. Improved access to funds
Co-lending helps make funds easily available to customers who are in most need of it, bridging the gap between traditional financial institutions and the unbanked population. The digital approach has further acted as a catalyst in loan origination where customers avail the support of both digital lender and banks.
2. Lower cost of loans
Co-lending helps push credit through the economy with automation and lower interest rates. This translates to lower cost of acquiring customers, gaining more market share, and disbursing more loans, the benefit of which can also be passed on to the customers.
3. Increase depositors
Co-lending allows banks to retain customers and maintain the customer’s depository relationship. It enables a path for a winning proposition of the bank and customer by maintaining long-term customer relationships, even during certain financial challenges from the customer’s end.
4. Promote portfolio growth
Since co-lending involves sharing risk, banks can finance high-growth companies that do not yet meet the credit requirements. Both NBFCs and banks help funnel prospective customers into participation, which helps customers build a good credit history with the bank.
For NBFCs, they enable customers to fit into the bank-only financing as soon as they qualify. This further eliminates capital constraints and promotes portfolio growth.
5. Increased client contact and shorter turnaround times
Co-lending helps banks expand their scope into new segments while reducing cost of capital for NBFCs. This helps NBFCs to incorporate automation and tools such as credit decisioning which allows them to process more loan applications and disburse more loans. This in turn leads to lowered turnaround times and underwriting costs.
Read more: India’s Neo-Banks: Lessons to Learn for Traditional Indian Banks and Lending Businesses
How Co-lending Enables Increased Availability of Credit
The retail credit market has always presented itself as an attractive opportunity in financial services. Co-lending is constantly helping to bridge the credit gaps by improving access to credit as well as credit management.
The co-lending model works by bringing together the availability of funds from banks and the strong local presence of NBFCs for credit disbursal. It acknowledges the expansion of credit by giving new-age lenders the chance to scale and reduce the friction with lender banks.
Non-banks are continuously improving their ability to assess the creditworthiness of niche customer segments by non-traditional sources of data and building customized scorecards to bring them under banks’ attention.
Co-lending is the holy grail of business for banks and NBFCs. The entire process of lending, right from co-origination of loans to settlement is mostly through automation which ensures that services are seamlessly delivered to the end consumers, improving credit availability.
Finezza is a multi-faceted lending management software tool that offers features like loan origination system, mobile ecosystem and APIs, and collection delinquency management. Contact us for more information about our products.
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