Unlocking Financial Synergy: The Power of Co-Lending

March 12, 2025 admin 0 Comments banks, co-lending, credit risk, digital lending, Financial Inclusion, Indian Economy, loan partnerships, MSMEs, NBFCs, Priority Sector Lending, RBI regulations

Introduction

Co-Leaning has become a regular feature of our daily newspaper and magazines. Not even a day goes by without seeing an article on Co-Leaning. Several banks have entered into co-lending ‘master agreements’ with registered Non-Banking Financial Companies (NBFCs) and more are in the pipeline. In 2020, the Reserve Bank of India (RBI) allowed the co-lending model based on a prior agreement.

In September 2018, the RBI had announced co-origination of loans by banks and NBFCs for lending to the priority sector. The arrangement entailed joint contribution of credit and sharing of risks and rewards. Co-lending or co-origination is a set-up where banks and non-banks enter into an arrangement for the joint contribution of credit for priority sector lending.

These guidelines were later amended in 2020 and rechristened as co-lending models (CLM) by including Housing Finance Companies and some changes in the framework.

Under priority sector norms, banks are mandated to lend a particular portion of their funds to specified sectors, like weaker sections of the society, agriculture, MSME and social infrastructure.

What is Co-Lending

Co-lending is an arrangement where multiple lenders, typically a bank and a Non-Banking Financial Company (NBFC), partner to provide loans to borrowers. This helps increase lending capacity and reduces risk for individual lenders. Each lender sets their own terms and conditions. This model leverages the strengths of both types of financial institutions to extend credit, especially to underserved markets. Co lending is used in various industries like real estate, small business loans and personal loans.

Key Players in Co Lending

Banks and Non-Banking Financial Companies (NBFCs) form partnerships to provide loans, with banks offering a part of the loan amount and NBFCs contributing the rest. This collaboration allows both parties to share the risk and profit generated from the loan, resulting in a smoother and more streamlined customer experience.

Co-lending benefits banks by helping them reach untapped markets and customers while NBFCs gain access to lower-cost funds, enhancing the overall customer experience by improved personal touch and better interface.

Examples of Co-Lending :

Union Bank of India and Capri Global Capital Limited (CGCL) : Union Bank of India has partnered with several non-banking financial companies (NBFCs) for co-lending. One notable partnership is with Capri Global Capital Limited (CGCL). This collaboration aims to provide loans to micro, small and medium enterprises (MSMEs), leveraging Union Bank’s extensive reach and Capri Global’s expertise in the MSME sector.

SBFC (Small Business Finance) and ICICI Bank : One notable co lending partnership is between SBFC (Small Business Finance) and ICICI Bank. This partnership allows the two entities to join forces and provide funding to borrowers who may not have been able to secure loans otherwise.

SBI and Adani Capital : The State Bank of India (SBI), the country’s largest lender, partnered with Adani Capital, a smaller NBFC, to co-lend to farmers. In this arrangement, SBI provides 80% of the loan amount, while Adani Capital contributes the remaining 20%. This partnership helps farmers access funds to purchase tractors and farm implements, combining the strengths of both institutions—SBI’s large capital base and Adani Capital’s reach to rural customers.

HDFC Bank and Apollo Finvest : HDFC Bank partnered with Apollo Finvest to provide loans to small and medium enterprises (SMEs). HDFC Bank contributes 80% of the loan amount, while Apollo Finvest provides the remaining 20%. This collaboration helps SMEs access funds more easily.

ICICI Bank and Indostar Capital Finance : ICICI Bank teamed up with Indostar Capital Finance to co-lend to the commercial vehicle sector. This partnership allows ICICI Bank to leverage Indostar’s expertise in the commercial vehicle market while sharing the risk.

Bank of Baroda and Paisalo Digital : Bank of Baroda entered into a co-lending agreement with Paisalo Digital to provide loans to micro, small and medium enterprises (MSMEs). This partnership aims to enhance credit availability to underserved segments.

Axis Bank and Lendingkart : Axis Bank has partnered with Lendingkart to provide working capital loans to small businesses. This partnership allows Axis Bank to leverage Lendingkart’s digital lending platform and extensive reach among small enterprises.

Yes Bank and U GRO Capital : Yes Bank teamed up with U GRO Capital to co-lend to MSMEs. This collaboration aims to enhance credit availability to small businesses, combining Yes Bank’s financial strength with U GRO Capital’s sector-specific expertise.

Kotak Mahindra Bank and InCred : Kotak Mahindra Bank has a co-lending partnership with InCred to provide loans to the education sector. This partnership helps students access educational loans more easily, leveraging Kotak’s financial resources and InCred’s focus on education financing.

These partnerships combine the strengths of both banks and NBFCs, improving credit outreach and making loans more accessible to various sectors.

Co Lending Models

Eligibility criteria for co-lending

The eligibility criteria for co-lending arrangements typically involve the following:

Credit Score and History: A good credit score and a stable credit history are crucial. Lenders will look at credit reports, including on-time payment history and credit mix, to assess the future ability to repay the loan.
Income: Stable income is necessary to ensure that borrowers have the means to repay the loan. Lenders may have different minimum income requirements.
Debt-to-Income Ratio (DTI): This ratio represents the portion of a borrower’s gross monthly income that goes toward monthly debt service. A lower DTI indicates a better ability to take on additional debt.
Collateral: For secured loans, lenders may require collateral, such as real estate or other valuable assets.
Age Limit: For certain loans like home loans, there might be an age limit for co-applicants, typically between 18 and 65 years.
Relationship: Some banks prefer couples as co-applicants for home loans, assessing the combined income for loan eligibility.

These criteria can vary depending on the lender and the type of loan. It’s important for potential co-borrowers to understand the specific requirements set by the lending institutions before pursuing a joint loan application. This knowledge ensures that both parties are prepared and meet the necessary criteria, leading to a smoother loan approval process.

Co-Lending Regulations

Co-lending, as a rapidly emerging trend in finance, needs to be regulated by the Reserve Bank of India (RBI) and the Ministry of Finance. To serve this purpose, regulators have issued regulations and guidelines to ensure the safety of borrowers and lenders alike. One such regulation issued by the RBI in November 2020 requires banks to maintain a minimum 20% share of the individual loans co-originated by them with NBFCs to avoid direct exposure to potential concentration risk.

This move was made to mitigate the potential concentration risk that may arise due to the involvement of a large number of NBFCs in co-lending arrangements. Additionally, the RBI has mandated that banks must ensure that the NBFC partner complies with all relevant norms and regulations to further minimize direct exposure to risks.

These regulations aim to create a single point of interface between banks and NBFCs, promoting transparency and reducing risks for both parties involved.

Terms & Conditions of Co-Lending Arrangement

Co-lending arrangements operate under mutually agreed terms and conditions, including the sharing of credit risk and interest income. The Reserve Bank of India and the Ministry of Finance have issued guidelines to regulate these arrangements, ensuring compliance with regulatory requirements and establishing a framework for seamless collaboration.

The agreement outlines the roles, responsibilities and liabilities of both the bank and the NBFC, creating a clear understanding of their respective contributions. This tripartite agreement is crucial in facilitating co-lending, allowing banks and NBFCs to jointly contribute credit and provide financial services to underserved customers at an affordable cost.

In a co-lending arrangement, banks and NBFCs collaborate to decide on loan terms through a structured process. Here are the key steps involved:

1. Risk Assessment and Credit Policies: Both parties conduct their own risk assessments and establish credit policies. They agree on the criteria for borrower eligibility, loan amount, interest rates and repayment terms based on their respective risk appetites and regulatory guidelines.

2. Loan Structuring: The loan is structured to leverage the strengths of both institutions. Typically, the bank provides a larger portion of the loan (e.g., 80%) while the NBFC contributes the remaining amount (e.g., 20%). This helps in risk-sharing and capital optimization.

3. Interest Rates and Fees: The interest rate is usually a blended rate, combining the rates offered by both the bank and the NBFC. Fees and charges are also agreed upon, ensuring they are competitive and attractive to borrowers.

4. Documentation and Processes: Both parties agree on the documentation required from borrowers and streamline their processes to ensure a seamless experience. This includes standardizing application forms, KYC (Know Your Customer) procedures and loan agreements.

5. Monitoring and Servicing: The responsibility for loan monitoring and servicing is divided between the bank and the NBFC. They establish protocols for regular monitoring, collections and handling defaults, ensuring effective management of the loan portfolio.

6. Regulatory Compliance: Both institutions ensure that the co-lending arrangement complies with regulatory requirements set by authorities like the Reserve Bank of India (RBI). This includes adhering to guidelines on loan classification, provisioning and reporting.

By collaborating on these aspects, banks and NBFCs can offer more competitive and accessible loan products to borrowers, leveraging their combined strengths and resources.

Co-Lending Infrastructure

Co-lending in India is supported by a robust infrastructure, including the use of escrow accounts to ensure secure and efficient transactions.

When selecting a co lending partner, it’s crucial to consider factors like reputation, financial stability and expertise in the target segment. Evaluate their technological capabilities and track record in co lending, as well as their understanding of regulatory requirements, including the use of escrow accounts.

A strong partnership built on trust and effective communication is essential for long-term success.

Applications of Co Lending

Co lending offers a wide range of application and opportunities across various sectors, including retail, MSMEs, agriculture and housing finance. It can be utilized for financing business loans, working capital requirements and capital expenditure.

This arrangement not only provides opportunities for product diversification and expansion into new markets but also enable lenders to share the credit risk and leverage each other’s strengths.

Advantages and Disadvantages of Co Lending

Co lending in the financial services sector offers numerous advantages to banks, NBFCs and consumers.

To Banks

Co lending presents an opportunity for banks to increase their share of credit to priority sectors.
By partnering with NBFCs, banks can tap into their expertise and reach in specific market segments.
Allows banks to benefit from product innovations and lower interest rates, ultimately expanding their loan portfolio.
Helps banks meet regulatory requirements like priority sector lending norms.
Enables banks enhance their presence in underserved areas, bridging the credit gap and providing financial services to potential customers.

To NBFCs

NBFCs can leverage their expertise in niche sectors and reach underserved customers.
Partnering with banks grants NBFCs access to lower-cost funds and a wider customer base.
This enables NBFCs to offer competitive interest rates and customized loan products, enhancing credit flow to priority sectors and supporting financial inclusion initiatives.
NBFCs can benefit from the technological interventions and digital penetration of their partner banks.
Co lending arrangements allow NBFCs to maximize their potential customer reach and contribute to filling the credit gap in the market.

To Consumers

Consumers benefit greatly from this arrangement, particularly underserved customers who may have limited access to credit.
Access to a wide range of loan products and enjoy competitive interest rates.
The process is faster as it reduces the turnaround time for loan approvals and disbursements.
It also plays a crucial role in ensuring the availability of credit in underserved sectors and rural areas.
Creates opportunities for small businesses and individuals to access affordable finance.

Co-lending, while beneficial in many ways, also has its disadvantages for banks, NBFCs, customers and the Indian economy. Here are some key drawbacks:

For Banks

1. Operational Complexity: Managing co-lending arrangements can be complex, requiring coordination between different systems, processes and teams.

2. Risk of Non-Performance: If the NBFC partner underperforms or faces financial difficulties, it can impact the overall loan portfolio and increase the risk for the bank.

3. Regulatory Compliance: Ensuring compliance with regulatory requirements for both entities can be challenging and resource-intensive.

For NBFCs

1. Dependency on Banks: NBFCs may become overly dependent on banks for funding, which can limit their operational flexibility.

2. Profit Sharing: The revenue from loans is shared with the bank, which can reduce the profitability for NBFCs compared to lending independently.

3. Operational Burden: NBFCs need to align their processes and systems with those of the bank, which can be resource-intensive.

For Customers

1. Confusion and Complexity: Customers might face confusion due to dealing with two entities for a single loan, leading to potential miscommunication and delays.

2. Higher Costs: The blended interest rates and fees from both entities might result in higher overall costs for the borrower.

3. Service Issues: Inconsistent service levels between the bank and NBFC can lead to a poor customer experience.

For the Indian Economy

1. Systemic Risk: Increased interconnectedness between banks and NBFCs can lead to systemic risks if one entity faces financial difficulties.

2. Regulatory Challenges: Ensuring that both banks and NBFCs adhere to regulatory standards can be challenging, potentially leading to gaps in oversight.

3. Market Distortion: Co-lending might lead to market distortions if not managed properly, with certain sectors receiving disproportionate credit while others are neglected.

While co-lending offers many advantages, these potential drawbacks need to be carefully managed to ensure the benefits outweigh the risks.

Mitigate risks in Co-lending :

Banks and NBFCs can mitigate risks in co-lending through several strategies:

1. Robust Credit Assessment

Joint Credit Policies: Develop and adhere to joint credit policies that outline borrower eligibility, loan terms and risk assessment criteria.
Due Diligence: Conduct thorough due diligence on borrowers, leveraging both entities’ expertise and resources.

2. Operational Integration

System Integration: Ensure seamless integration of IT systems to facilitate smooth data sharing and loan processing.
Standardized Processes: Standardize loan origination, documentation and servicing processes to minimize operational discrepancies.

3. Risk Sharing

Proportional Risk Sharing: Clearly define the proportion of risk each party will bear (e.g., 80% by the bank and 20% by the NBFC) and adhere to this structure.
Regular Monitoring: Implement regular monitoring and reporting mechanisms to track loan performance and identify potential issues early.

4. Regulatory Compliance

Adherence to Guidelines: Ensure compliance with regulatory guidelines set by authorities like the Reserve Bank of India (RBI) to avoid legal and financial penalties.
Transparent Practices: Maintain transparency in all dealings, including clear communication with borrowers about the co-lending arrangement and their rights.

5. Diversification

Portfolio Diversification: Diversify the loan portfolio across different sectors and borrower profiles to spread risk.
Geographical Spread: Expand lending activities across various regions to mitigate regional economic risks.

6. Customer Interface

Single Point of Contact: Designate a single point of contact for borrowers to streamline communication and reduce confusion.
Customer Education: Educate customers about the co-lending model, including the roles of both the bank and the NBFC, to build trust and transparency.

7. Regular Audits

Internal Audits: Conduct regular internal audits to ensure compliance with agreed-upon policies and procedures.
Third-Party Audits: Engage third-party auditors to provide an unbiased assessment of the co-lending arrangement and identify areas for improvement.

By implementing these strategies, banks and NBFCs can effectively manage and mitigate the risks associated with co-lending, ensuring a more stable and successful partnership.

Impact on Indian Economics:

Co-lending can have a positive impact on the Indian economy by:

Increasing the availability of credit to various sectors.
Promoting financial inclusion by reaching underserved markets.
Stimulating economic growth through increased lending activity.

The co-lending model has been encouraged by the Reserve Bank of India (RBI) with guidelines that typically include an 80-20 capital deployment ratio between the bank and the NBFC. This collaboration between banks and NBFCs aims to combine their respective capabilities and resources to enhance the lending experience for customers and contribute to the economic development of the country.

The Future of Co-Lending

Co-lending is emerging as a significant trend in the financial industry, offering a collaborative approach to lending that combines the strengths of multiple financial institutions. As it gains traction in the financial services industry, the future looks promising. The joint contribution of credit by multiple lenders offers benefits like financial inclusion, diversification, reduced risk and access to larger loan amounts.

This growing trend is set to disrupt the traditional lending industry, attracting more lenders and borrowers. With housing finance companies and other financial institutions embracing co lending, there is potential to bridge the credit gap and offer affordable cost loans to underserved customers.

The entire process, from application to recovery of interest, is streamlined, saving a lot of time for both lenders and borrowers. Co-lending is poised to redefine the lending landscape, making it more inclusive, efficient and resilient.

Arun Kumar Gupta

PF No. 525873

Faculty – Credit

Chief Manager

Zonal Learning Centre-Mangaluru