Co-lending: Transforming the priority sector

Mini, small, and medium enterprises employ over 100 million workers and contribute significantly to India’s GDP. However, the pandemic had adversely impacted the sector. According to an EPW survey, in May 2020, MSMEs production fell from an average of 75% of capacity to just 13%. On average, firms retained only 44% of their workforce, and 69% of firms reported an inability to survive longer than three months.

As a result, RBI came up with a co-lending policy with an objective to increase the credit flow in the priority sector. Under this policy, banks can partner with registered NBFCs (including housing finance companies) based on a predefined risk and reward ratio. Non-banking financial companies act as a single point of interface for customers. Banks further lend to the NBFCs and NBFCs further transfer it to the priority sectors. This makes the lending process convenient and funds affordable for the priority sector.

Basically, co-lending transforms banking at the grass root level by bringing credit to those who traditionally do not qualify for this, thereby bridging the unmet credit gaps in the Indian economy.

Let’s understand how co-lending benefits the priority sector:

1.       Increased Cash Flow in Economy

Led by fintech and NBFCs, digital lending is growing exponentially. This is, however, constrained by liquidity. To avoid the risks of systemic liability and financial meltdown, banks maintain caution while offering loans. India’s regulations in this regard were not futuristic. Come 2018, RBI released a model for banks and NBFCs to partner and provide credit to priority sectors. This matured as the co-lending model (CLM) in 2020, giving an opportunity to lenders to extend credit to the priority sector.

2.       Prevention of Systemic Liability

Co-lending allows lenders to manage capital efficiently and reduce liability, allowing them to scale by finding lending partners with a good product-market fit. To ensure no negative impact on the profit and loss statement, the on-balance sheet spread should be less than or at most equal to the off-balance sheet spread. Since the co-lending model is a partnership between banks and NBFCs, this ensures increased compliance as both parties must maintain it, thus preventing system liability.

3.       Simplified Partner Acquisition and Onboarding

Banks have the flexibility to partner with one or more banks, based on RBI guidelines around lending experience/CRAR/ratings, etc. A simplified partner onboarding journey, including but not limited to, escrow account creation, and master agreement generation makes it easy to add partners who have got model or structure to cater to the priority sector.

4.       Affordable Credit

Public sector banks have access to the cheapest source of funds in the economy. Since banks are onboard and 80% of the capital is released from the bank, it reduces the final interest charged to the end customer. NBFCs can take advantage to provide credit at lesser interest to their customers as compared to the competitors. Consequently, the co-lending model enables grassroots-level borrowers to get loans at an affordable and competitive rate.

5.       Portfolio Growth

Co-lending enables financial institutions to break the vicious cycle, where banks were not able to provide loans to many potential businesses due to the absence of credit history. Once the customer receives the loan, they can slowly build a good credit history, qualifying for financing directly from a single bank, thus promoting portfolio growth.

6.       Timely Credit

By leveraging automation and decision-making tools, co-lending enables banks to improve margins by processing more applications and disbursing more loans in a very short time. Artificial intelligence and machine learning-powered solutions can help lenders by analyzing customer patterns and predicting customers’ probability of default. It helps them to make quick and intelligent decisions while offering credit to potential customers, thereby accelerating the processing time and helping customers to get credit on time.  

7.       Knowledge Dissemination

NBFCs and HFCs educate their underserved and unserved customers about co-lending terms and conditions, thereby disseminating financial knowledge among them. This also helps the customers to understand the various aspects of financial management.

In a Nutshell

The co-lending model is rejuvenating the masses earning their livelihood through MSMEs. Banks are leveraging this model to tap into the untapped market, including financing farmer-producer organizations (FPOs), farm mechanization, and warehouse receipt finance. It also enables farmers to get loans from the formal credit market at an affordable interest rate, thereby doubling their income, improving their family’s economic status, and building a platform for further growth.

The article has been written by Kaushal Verma, Associate Vice President− Banking Centre of Excellence, Newgen Software