Bank-NBFC co-lending

Context: Recent partnership of SBI with Adani Capital under the RBI’s Co-lending framework has drawn criticism from Opposition party politicians.

• Reason for criticism: This will only benefit the private firm more by taking unfair advantage of a SBI which has extensive reach and expertise.

About Co-Lending Model (CLM)

• Co-lending or co-origination is a set-up where banks and non-banks (NBFCs) enter into an arrangement for the joint contribution of credit for priority sector lending.
• It was formulated by Reserve Bank of India (RBI) in 2018.
• Aim: To improve the flow of credit to the unserved and underserved segment of the economy at an affordable cost.
• Under this arrangement, both banks and Non-Banking Financial Corporations (NBFCs) share the risk in a ratio of 80:20.
• It expands lending in priority sectors including rural areas, renewable energy and Micro Small and Medium Enterprises (MSMEs).

How do they work?

• In a Co-lending model, two lender firms come together to disburse loans.
• Here, NBFCS facilitate the origination and collection of housing loans while banks leverage their balance sheet strength to house the majority of the loan.
• Banks will lend to NBFCs, and NBFCs will pass it on to the priority sectors.
• NBFCs act as the single point of interface for the customers and a tripartite agreement is done between the customers, banks and NBFCs.
• The agreement should contain the features of the arrangement and the roles and responsibilities of NBFCs and banks.
• The ultimate borrower would be charged an all-inclusive interest rate.
• Upon maturity, the repayment or recovery of interest is shared by the bank and NBFC in proportion to their share of credit and interest.

Key Challenges

• Ground-level executions: Though Banks and NBFCs both are open for tie-ups, there are challenges in execution at ground level.
• Tech integrations: IT integration of systems is difficult as both banks and NBFCs operate on different systems, different underwriting processes and parameters.
• Preference for term loans: Most of the mid-sized well-rated NBFCs opt for term loans over entering into co-lending models

Benefits of Co-Lending

• It will ensure delivery of credit to the unserved and underserved, thereby addressing the credit gap.
• This is possible as banks have lower cost of funds and NBFCs have greater reach beyond tier-2 centres.
• It can be an opportunity for digital lending start-ups and mid-size NBFCs, to establish their strength of distribution with bank’s funds.
• It allows banks to expand their customer base as NBFCs have access in tier-3 and tier 4 cities.
• Tier 3 cities are those cities with a population between 20,000 to 49,999
• Tier 4 cities are those cities with a population between 10,000 to 19,999
• The model can fulfil the credit requirements of the priority sector segments.
• Banks can connect with the underserved farming segment of the country and further contribute towards the growth of India’s farm economy.

Criticism
Increased risk for the Banks

• 80 % of the risk will be with the banks.
• NBFCs are required to retain at least a 20 % share of individual loans on their books.

Limitations of the Bank
The terms of the agreement provide for the banks

• to either mandatorily take their share of the individual loans originated by the NBFCs on their books, or
• to retain the discretion to reject certain loans after due diligence prior to taking them on their books.

Greater role for NBFC

• The RBI guidelines provide for the NBFCs to be the single point of interface for customers.
• NBFC decides the borrower, while the banks fund the major chunk of the loan.
• NBFCs have more opportunities on the lending side through direct co-lending arrangements.