Types of Banks and Banking

Economic Affairs

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Indian Economy - Understanding the basics of Indian economic system

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.