In recent times, a growing number of banks have forged ‘master agreements’ for co-lending with registered Non-Banking Financial Companies (NBFCs). This was made possible when the Reserve Bank of India (RBI) permitted the co-lending model in 2020 based on an earlier agreement. However, this model has come under some criticism.
Background of the Co-Lending Model
The RBI first introduced the concept of co-originating loans by banks and NBFCs for priority sector lending in September 2018. This involved a joint credit contribution and shared risks and rewards. The co-lending or co-origination setup sees banks and non-banks entering into an agreement for joint credit contribution for priority sector lending. In 2020, these guidelines were revised and renamed as co-lending models (CLM), which incorporated Housing Finance Companies, and made slight adjustments to the framework. Banks are required by priority sector norms to lend a specific portion of their funds to designated sectors, such as weaker societal sections, agriculture, MSME, and social infrastructure.
Purpose of the Co-Lending Model
The main objective of the ‘Co-Lending Model’ (CLM) is to enhance the flow of credit to the unserved and underserved parts of the economy. It also aims to provide funds to recipients at an affordable cost.
Driving Force Behind Co-Lending Model
The Co-Lending Model (CLM) seeks to efficiently utilize the respective advantages of banks and NBFCs in a cooperative effort. This includes the lower cost of funds from banks and the wider reach of NBFCs. This model aims to improve last-mile finance and promote financial inclusion, particularly for MSMEs. As an example, State Bank of India (SBI) recently signed a deal with Adani Capital to co-lend to farmers for purchasing tractors and farming equipment.
Risks in Co-Lending
However, there are certain risks connected with the CLM. Most notably, the majority of responsibility lies with the banks. Under the CLM, NBFCs only need to retain a 20% share of individual loans on their books. This implies that banks bear 80% of the risk and will take a significant hit in case of a default. While banks fund the lion’s share of the loan, the NBFC chooses the borrower.
The Role of Corporates in Banking
Though the RBI hasn’t officially sanctioned the entry of major corporate houses into banking, most NBFCs are run by such corporates. This presents a risk, particularly considering the recent collapse of four major private finance firms, IL&FS, DHFL, SREI, and Reliance Capital, despite stringent RBI monitoring.
Reach of NBFCs: An Issue
Despite the RBI’s mention of “the greater reach of NBFCs”, smaller NBFCs with a network of around 100 branches are unlikely to adequately serve underserved and unserved segments.
Going Forward
The way forward would entail giving more power to the bank’s board to direct, review, and oversee the decision-making process. This would require recruiting top talent. There is also a need for a stronger risk management mechanism. Looking at foreign markets and establishing suitable business policies that improve efficiency and competitiveness against global counterparts is necessary. Continuous reforms concerning product innovation, investments in technology, improved back-end processes, and reduction in turnaround time should be undertaken regularly.