Co-lending is a mechanism devised by RBI, to ensure that low-cost funds of banks are made available to NBFCs who essentially operate in deeper geographies & work in the MSME, EWS, LIG & MIG categories where Banks are slightly shy of lending due to higher operating cost & credit risk as well.
The co-lending model allows NBFCs to seek funds at low cost from Banks vide a tie-up arrangement and requires them to put in the balance 20% from their sources of funds. This 80:20 ratio ensures that the NBFC does not originate poor quality loans as their 20% stake would also get impacted with losses that would arise from such originations.
This mechanism ensures a win-win situation for all three parties viz borrower, bank, and NBFC. The borrowers get the funds at a lower cost than what he/she would have gotten on a standalone basis from the NBFC. The Bank would get better deployment of their funds in the unserved and underserved sector and the NBFC would have a steady flow of economical and reliable sources of funding.
If the model is so good, then what is plaguing its growth?
The complexity of the model – The model requires Banks to publish their credit policy for accepting such loans. Further banks and NBFCs have to enter into a master agreement on loan servicing and customer service. There is also a complex accounting methodology that needs to be set up for the 3 components of co-lending viz 80%, 20% & 100%. Separate accounts need to be maintained for the Bank, NBFC & Borrower.
Demand-supply mismatch in the PSL segment –Banks are normally short on the priority sector lending mandate of RBI, and they depend on NBFC to sell them their loans. (since NBFCs do not have such a mandate) The supply of PSL loans by NBFC is far lower than their demand, making the commercial negotiation between the banks and NBFC very lopsided in favour of NBFC. NBFCs also keep most of the other earnings by way of processing fees, insurance commissions, additional interest rates, cheque bouncing charges, penal interest, etc.
The curious case of blended cost of fund and borrower’s rate of interest – NBFCs say that they are not sure whether Banks would approve a particular loan originated by them for co-lending during the pool selection by banks and therefore cannot pass on the benefit of the blended cost to the borrower at the time of origination. This is a big concern as this uncertainty ends up defeating the purpose of co-lending at a lower interest rate as was envisaged by the regulator
NBFC customer segment does not overlap with Bank –The credit profiles of NBFC customers are relatively riskier and hence the likelihood of higher credit loss cannot be ruled out. Banks also complain that their ability to absorb higher credit loss is very limited. Banks have very little understanding of the credit risk of NBFC borrowers.
Regulatory compliances are different for Banks and NBFCs – The regulatory standards for banks and NBFCs are different hence there are issues around know-your-customer (KYC) norms, collateral norms, etc.
Do these issues make the co-lending model unviable?
Well, the benefit of the model far outweighs the concerns on both sides. Some solutions will emerge from these challenges which will hopefully make this model a great success.
Some IT & fintech companies have already come up with accounting and escrow solutions for the NBFC and Banks.
The demand-supply mismatch will solve itself over time, unless co-lending takes off, the supply will not improve as NBFCs find it very difficult to raise funds for lending. Unless NBFCs grow in scale and prove their ability to manage credit, liquidity risk, etc well, the issue of NBFC scale will not get solved. Co-lending provided this perfect opportunity to take care of the initial concerns of low-cost debt funds for lending. As the co-lending model grows, the competition amongst NBFCs will ensure that the blended cost is passed on to the end customer.
On the issue of Banks not understanding the credit nuance of this segment, it will get sorted out over time as banks gain experience in managing these acquired portfolios and can see the performance of these segments over time. There are guarantee companies in the MSME and home loan space in India. that can be leveraged by the Banks while defining their risk appetite for the co-lending business with NBFC and also taking credit default guarantee up until they are ready to take on this risk on their own.
The commercial terms between banks and NBFC, as both start to see the benefits, will eventually get settled despite the demand-supply mismatch in the PSL sector.