To improve the flow of credit to the unserved and underserved sections of the economy, in September 2018, the Reserve Bank of India (RBI) had put in place a framework for ‘Co-origination of loans’ by banks and non-banking financial companies (NBFCs). It will also ease lending to priority sectors of the economy, which include agriculture, housing, education, micro, small and medium enterprises (MSMEs), social infrastructure, and renewable energy among others. The arrangement entailed joint contribution of credit at the facility level by both the lenders as also sharing of risks and rewards, according to the RBI. However, housing finance companies (HFCs) were not allowed to co-lend with banks under this framework. As a result, the framework failed to take a broad shape.
The Co-Lending Model between Banks and NBFCs
In November 2020, the RBI came out with the amended framework, called ‘Co-Lending Model’ (CLM). Under the CLM, banks can provide loans along with registered NBFC (including HFCs), i.e., co-lend to priority sector borrowers based on a prior agreement. It is a set-up where both banks and NBFCs enter into an arrangement for joint contribution of credit to the priority sectors. This model seeks to provide a greater flexibility to the lending institutions in order “to better leverage the respective comparative advantages of the banks and NBFCs in a collaborative effort.”
According to the RBI, the primary focus of the CLM is to make available funds to the ultimate beneficiary at an affordable cost, considering the lower cost of funds from banks and greater reach of the NBFCs.
Salient Features of the CLM
Under the CLM, NBFCs shall be required to retain a minimum of 20 per cent share of the individual loans on their books while 80 per cent of share shall be with the banks with the credit risk in the ratio of 20:80.
As per a notification by the RBI, NBFCs shall be the single point of interface for customers to enter into a loan agreement, containing clear features of the arrangement, and the roles and responsibilities of NBFCs and banks.
The ultimate borrower will be charged an all-inclusive interest rate as agreed upon by both the lenders, which will have to establish a framework for monitoring and recovery of the loan. And, any assignment of a loan by a co-lender to a third party can be done only with the consent of the other lender.
The co-lending banks and NBFCs shall maintain each individual borrower’s account for their respective exposures. However, all transactions (disbursements/repayments) between the banks and NBFCs relating to CLM shall be routed through an escrow account maintained with the banks in order to avoid inter-mingling of funds. An escrow account is the third-party account which holds the asset on behalf of the two parties (who are in the process of completing a transaction) until the conclusion of a specific event or time.
With regards to grievance redressal, a suitable arrangement will be put in place by the co-lenders to resolve any complaint registered by a borrower with the NBFC within 30 days, failing which the borrower would have the option to escalate the same with the concerned banking ombudsman/ombudsman for NBFCs or the Customer Education and Protection Cell in the RBI.
Benefits of the CLM
Proper take-off and right execution of the CLM will ensure last mile delivery of credit to the unserved and underserved sectors of the economy. For instance, State Bank of India (SBI), country’s largest lender, has tied up with Adani Capital, a small NBFC, for co-lending to farmers to help them buy farm equipment. This may prove immensely helpful for the farm sector in improving its income and productivity.
Partnership with NBFCs will allow banks to lend more funds to the unserved and underserved sectors and regions in the country. With greater reach of NBFCs, the model will allow banks to meet their priority sector lending (PSL) targets. (PSL directions require domestic and foreign banks to achieve a credit disbursement target of 40 per cent of lending book to the priority sectors of the economy. However, regional rural banks (RRBs) and small finance banks (SFBs) are required to achieve 75 per cent. The directions were last revised in September 2020.)
The CLM provides an opportunity for the digital lending start-ups and mid-sized NBFCs as they can actually marry their strengths of wider reach and distribution with banks’ funds.
With HFCs (under NBFCs) also included for co-lending, interest rates may come down for loans given by HFCs. This will help the HFCs to expand leverage capacity and unlock value.
Banks being flush with funds and NBFCs having wider reach and spread in tier-3 (population between 20,000–49,999) and tier-4 cities (population between 10,000–19,999), the marriage will allow the co-lenders to cater to a large customer base.
Challenges
The first and foremost challenge pertains to technology. Banks and NBFCs operate on different IT systems. IT integration of their systems is the most important challenge to be dealt with.
According to Gaurav Gupta, chief executive officer (CEO) and MD of Adani Capital, “Banks have to adopt NBFCs’ underwriting process and parameters, which may be different from that followed by banks. If there are many changes to be done, it may be difficult for NBFCs to switch between sole and co-lending mid-way through the underwriting process”. And what can prove irksome is banks expecting NBFCs to adopt their policies, “which will make it no different from a business-correspondent structure,” he added.
As per industry experts, there are obvious operational challenges with the model as the turn-around time of banks for approvals is much longer than that of NBFCs. This may blunt the competitiveness of the model.
The RBI requires that NBFCs will have to give an undertaking to the partner bank that the contribution towards the loan amount should not be funded out of borrowings from the co-originating bank, or any other group company of the partner bank. It is to be noted that whereas banks have current and savings accounts, NBFCs are primarily funded through debentures and commercial papers, a route made tougher with the new asset-liability norms in place. Clearly, there is a need for a fine balancing act.
Way Forward
In an attempt to address the huge credit gap in the economy, especially in the unserved and underserved sectors, the CLM is the right way to go forward. Challenges related to technological integration of their systems as well as those related to ground-level integrations must be sorted out.
In her interaction with the managing directors of public sector banks, the finance minister Nirmala Sitharaman emphasised the necessity of making the CLM work to enhance affordable credit to MSMEs and retail sectors. According to her, the focus should be towards credit growth to support MSMEs and the underserved segments. As pointed out by Gaurav Gupta, Adani Capital MD and CEO, the model will help make economic capital available to the micro-entrepreneurs of India.
© Spectrum Books Pvt Ltd.