Can Co-lending Models (CLM) Be The Future Lending In India?

The Reserve Bank of India (RBI) had come out with the co-origination framework in 2018 allowing banks and NBFCs to co-originate loans. These guidelines were later amended in 2020 and rechristened as co-lending models (CML) by including Housing Finance Companies and some changes in the framework.

The primary aim of the guideline was to improve the flow of credit to the unserved and underserved segment of the economy at an affordable cost. This happens as banks have lower cost of funds and NBFCs have greater reach beyond tier-2 centres.

What is Co-Lending?

Co-lending occurs when two lender firms come together to disburse loans. The association allows firms to source clients, perform credit appraisals and disburse a small part of the loan amount. Simultaneously, the arrangement enables a bank to lend out more funds.

The process involves Banks leveraging balance sheet strength which houses the majority of the whole loan amount while the NBFCs and HFCs enable origination and smooth collection. In essence, banks can lend to registered NBFCs and HFCs. These Institutions pass it on to individuals and organizations in priority sectors. This is because NBFCs and HFCs have greater reach than banks in many parts of the country.

Why Co-Lending Was Needed?

The co-lending model empowers multiple stakeholders of the lending ecosystem. While NBFCs and HFCs can leverage their strong presence in local markets, commercial banks have the availability of funds for credit disbursal. This becomes even more relevant in the current scenario where many NBFCs are battling against the liquidity crunch.

Another advantage of this partnership is that NBFCs and HFCs have mastered the art of assessing the creditworthiness of certain niche customer segments, which the banks have been ignoring, primarily due to differences in their core target segment and credit risk management approach.

Problem It Solves For Indian Economy

Co-lending effectively solves two related issues of utmost importance—liquidity and systemic stability.

Liquidity- Liquidity means financial institutions capacity to fund the increase in asset and meet its financial obligation on time. On the this front, co-lending acknowledges that any meaningful expansion of credit has to come from the banking system at the back end. 60 percent of the country’s liquidity reserves reside within the public sector banks (PSB) system alone. New-age lenders must tap into this liquidity to scale.

Co-lending offers a framework for implementing the partnership, which could over time evolve into a set of standards that eliminate the typical friction in lender-bank partnerships.

Systemic stability- It means the ability of the financial system to consistently supply the credit intermediation and payment services that are needed in the real economy if it is to continue on its growth path. Systemic stability is where co-lending truly scores as a model.

As a partnership between two—regulated entities, i.e. a bank and an NBFC, it ensures a high degree of standardisation, compliance, fiduciary care, and customer protection. Borrowers are underwritten not once, but twice and by two different entities, and risk governance is a mutually reinforced exercise with adequate checks and balances.

Co-lending also functions as a superior form of market-making for debt asset generation, with mandatory skin-in-the-game for the originator and risk-sharing through the 80:20 mechanism as per RBI guideline.

What Is Leading To The Popularity of Co-lending Method Globally?

Higher Reach & Faster Turnaround

Co-lending not only allows traditional banks to reach emerging markets and previously non-banked sectors through NBFCs, but it also allows them to churn more applications and disburse more loans thereby improving margins by employing automation and tools like decisioning and alternative credit scoring that reduce underwriting costs and time, substantially.

Increased Access to Fund

NBFCs act as a bridge between the previously unbanked population and traditional banks by providing easy access to credit for individuals and small businesses who did not have any credit rating earlier. While traditional banks fund 80% of the sanctioned loan amount, NBFC’s fund the remaining 20%.

Reduced cost of lending

The ability to automate the loan origination process has helped banks and NBFCs pass on the cost-benefit in the form of lowered interest rates. This means they can capture larger markets, gain more market share, process, and disburse more loans thereby pumping in more credit through the economy.

Sharing of Risk & Return

Collaboration would not only mean improvement of lending strategies and development of technology, but it would include sharing of different forms of risks and returns between the banks and NBFC.