Co-lending may be just what the doctor ordered for improving the flow of credit to the unserved and underserved sectors of the economy at an affordable cost, going by the flurry of tie-ups between banks and non-banking finance companies (NBFCs) in the last few months. Top bankers and NBFC chiefs say the co-lending model (CLM) is a win-win proposition for banks, NBFCs and their customers.

The Reserve Bank of India (RBI) had issued a circular to scheduled commercial banks (excluding small finance banks, regional rural banks, urban co-operative banks and local area banks) on CLM on November 5, 2020, with a view to better leverage the comparative advantages of banks and NBFCs in a collaborative effort in respect of all categories of priority sector lending.

In view of incipient stress in micro, small and medium enterprises (MSME), there is a possibility that once the Emergency Credit Line Guarantee Scheme (ECLGS) ends on March 31, 2022, bankers may turn more circumspect in lending to MSMEs. But co-lending tie-ups can assuage any concerns they may have in lending to MSMEs.

ECLGS provides 100 per cent guarantee coverage from the National Credit Guarantee Trustee Company to select borrowers. Banks have restructured 24.51 lakh MSME accounts aggregating ₹1,16,332 crore since January 2020 in the wake of the pandemic, as per RBI data. There is uncertainty as to how these accounts will perform in the third wave of the pandemic. So, banks can overcome their risk aversion through co-lending partnerships with NBFCs, which have demonstrated their prowess in sourcing, underwriting, disbursing and collecting loans.

CLM is based on the symbiotic relationship between banks and NBFCs. Lower cost of funds from banks and the greater reach of the NBFCs are is expected to benefit borrowers. Under CLM, NBFCs are required to retain a minimum of 20 per cent share of the individual loans on their books, with the balance being held by banks. It is the mid- and small-sized NBFCs with below ‘AA’ rating, whose cost of funds is relatively higher, that are entering into tie-ups with banks.

NBFC ratings

However, large NBFCs with‘AA’ and ‘AAA’ ratings, which can are able to access low-cost resources from the market, see no particular advantage in partnering with banks. “ NBFCs are more efficient in sourcing, lending and collecting. What they lack is the cheaper source of funds, which we have. So, the partnership (between banks and NBFCs) is a win-win,” Rajkiran Rai G, MD & CEO, Union Bank of India, said at the FICCI-IBA Conference (FIBAC) last month.

But getting CLM right is a big challenge as there are multiple issues – balance-sheet based lending model of banks versus cashflow based lending model of NBFCs; valuation; eligibility criteria (for example, relating to income); etc – that need to be addressed. “We are focussed more on policies and have very rigid filters. So, you (borrowers) have to fit into that then only you will get a loan.

Whereas NBFCs are more amenable to changes/flexibility flexible. “We are more data-driven whereas NBFCs are more practical. So, they look at a shop, footfalls, cashflows , and decide the customer can repay and they can take the risk. That is the basic difference between NBFCs and banks,” explained Rai.

The Union Bank chief underscored that his Bank is developing products, which are a hybrid between a pure bank product and a pure NBFC product, suitable for co-lending. Rai underscored that co-lending cannot happen through a traditional branch, which does traditional credit products because for staff mindset will be a big issue.

“So, we created a separate branch and a separate team, which is groomed specifically for sanctioning loans under CLM. “...the ultimate beneficiary will be the customer because he will get money easily and at the right price. Everybody is positive about this model. We can build on that,” Rai said.

Financial sector expert PH Ravikumar noted that when banks look at co-lending, they look at NBFCs which, on a monthly basis, originate some decent amount relevant for their balance sheet. “If you take, say, State Bank of India, Bank of Baroda, ICICI Bank, and HDFC Bank, if an NBFC does monthly origination of less than ₹100 crore, it does not make a difference to their balance sheet.

“When it comes to microfinance or MSMEs, the ability of specialised NBFCs to spot, manage and contain the risk is much better than large banks. NBFCs have the skill sets, local focus, and local intelligence. Besides a structured approach, physical touch and feel are is also important to assess credit,” he said.

So, increasingly co-lending becomes important provided there is a minimum monthly origination. Ravikumar opined that banks, therefore, give lines of credit to NBFCs, become familiar with them and understand their ability to originate, manage and contain risk. And the moment they are comfortable with that they move to co-lending.

Prashant Kumar, MD & CEO, YES Bank, observed that in a very short time (just six months), his Bank has been able to fully implement co-lending partnerships with three large NBFCs. “And every month we are adding almost ₹300 crore... And we have a clear visibility, whereby we would be able to do something around ₹1,000 crore per month,” Kumar said.

Advantage of co-lending

Shachindra Nath, Executive Chairman and Managing Director, U GRO Capital, emphasised that the advantage of co-lending is that the bank knows that though it using the NBFC’s intermediation, eventually its end exposure is not to the NBFC but to an end customer. “In the next two years, co-lending (riding on the data tripod of GST, banking and bureau) will become the mainstay of providing capital to the last mile through NBFC as an intermediary. And I have no doubt about this,” he said at FIBAC.

Nath is of the view that collaboration between large banks and niche NBFCs/fintech, wherein lending as a service (LaaS), would become a prominent force. Boston Consulting Group (BCG), in a recent report, said that driven by adverse selection, public sector banks (PSBs) have had extremely poor debt experience in small business finance resulting in their declining growth and receding relevance in this important segment.

PSBs would benefit, in particular, from partnerships with third party platforms and NBFCs/fintechs with last mile reach, it added. The global consulting firm is of the view that CLM needs to be reimagined as an open digital marketplace as against a cumbersome to operationalise one bank-to-one NBFC contract “Co-lending framework is a great enabler for flow of credit to SME with NBFC bridging the last mile. In its current form, as a one-to-one deal, it is very cumbersome and slow to implement,” BCG said.

The firm observed that RBI should reimagine co-lending as an extension of the Open Credit Enablement Network (OCEN) framework into the secured lending domain with standardised protocols for a range of issues from credit appraisal, accounting, NPA recognition, security creation and enforcement, among others. First Loss Default Guarantee (FLDG) is a powerful enabler of partnerships.

“We need to institutionalise a regulatory framework to establish FLDG by Lending Service Providers (LSPs) to a lender with provision of appropriate mandatory regulatory capital to back it. A separate NBFC (FLDG) licence may be created for specific purpose of regulating such LSP,” BCG recommended.