TOPIC : BANK-NBFC CO-LENDING MODEL

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THE CONTEXT: A November 2020 decision by the Reserve Bank of India (RBI) to permit banks to “co-lend with all registered NBFCs (including HFCs) based on a prior agreement” has led to unusual tie-ups like the one announced in December 2021 between the State Bank of India (SBI) and Adani Capital. This article analyses the issue in detail.

THE ‘CO-LENDING MODEL’

• In September 2018, the RBI had announced “co-origination of loans” by banks and Non-Banking Financial Companies (NBFCs) for lending to the priority sector. The arrangement entailed joint contribution of credit at the facility level by both the lenders as also sharing of risks and rewards”, the RBI said.
• Subsequently, based on feedback from stakeholders and “to better leverage the respective comparative advantages of the banks and NBFCs in a collaborative effort”, the central bank allowed the lenders greater operational flexibility while requiring them to conform to regulatory guidelines.
• The primary focus of the revised scheme, rechristened as ‘Co-Lending Model’ (CLM), was to “improve the flow of credit to the unserved and underserved sector of the economy and make available funds to the ultimate beneficiary at an affordable cost, considering the lower cost of funds from banks and the greater reach of the NBFCs.

HOW DOES A CO-LENDING MODEL WORK?

• The Reserve Bank of India (RBI) came out with the co-origination framework in 2018, allowing banks and NBFCs to co-originate loans. These guidelines were later amended in 2020 and rechristened as co-lending models (CML) by including Housing Finance Companies and some changes in the framework.
• The primary aim of CLM is to improve the flow of credit to the unserved and underserved segments of the economy at an affordable cost. This happens as banks have lower costs of funds and NBFCs have greater reach beyond tier-2 centres.
• A minimum of 20 percent of the credit risk by way of direct exposure shall be on NBFC’s books till maturity and the balance are on the bank’s books. Upon maturity, the repayment or recovery of interest is shared by the bank and NBFC in proportion to their share of credit and interest.
• This joint origination allows banks to claim priority sector status in respect of their share of the credit. NBFCs act as the single point of interface for the customers and a tripartite agreement is done between the customers, banks and NBFCs.

BANK-NBFC TIE-UPS

• Several banks have entered into co-lending ‘master agreements’ with NBFCs, and more are in the pipeline.
• In December 2021, SBI, the country’s largest lender, signed a deal with Adani Capital, a small NBFC of a big corporate house, for co-lending to farmers to help them buy tractors and farm implements.
• SBI’s giant network includes 22,230 branches, 64,122 automated teller machines (ATMs) and cash deposit machines (CDMs), and 70,786 business correspondent (BC) outlets across the country. Adani Capital has a network of just 60 branches and has disbursed around Rs 1,000 crore, according to its website.
• On November 24, Union Bank of India entered into a co-lending agreement with Capri Global Capital Ltd (GCC), with the aim “to enhance last-mile finance and drive financial inclusion to MSMEs by offering secured loans between Rs 10 lakh to Rs 100 lakh” initially through “100+ touch points pan-India”.

CORPORATES IN BANKING

• While the RBI hasn’t officially allowed the entry of big corporate houses into the banking space, NBFCs, mostly floated by corporate houses, were already accepting public deposits. They now have more opportunities on the lending side through direct co-lending arrangements.
• This had come at a time when four big finance firms — IL&FS, DHFL, SREI and Reliance Capital — which collected public funds through fixed deposits and non-convertible debentures, have collapsed in the last three years despite tight monitoring by the RBI. Collectively, these firms owe around Rs 1 lakh crore to investors.
• While the RBI has referred to “the greater reach of the NBFCs”, many bankers point out that the reach of banks is far wider than small NBFCs with 100-branch networks in serving underserved and unserved segments.

WHAT TOOK SO LONG FOR CO-LENDING TO TAKE OFF?

• On several occasions, the Ministry of Finance has pushed for PSU banks to adopt co-lending models. Some of the PSU banks in the initial days had tied up with large non-banks. For instance, SBI had tied up with ECL Finance, a subsidiary of Edelweiss Financial Services, in September 2019.
• But some of these tie-ups didn’t take off as expected. According to bankers, banks and NBFCs both are open for these kinds of tie-ups, but the challenge was in execution at ground level.
• Some of the main hurdles were IT integration of systems as both banks and NBFCs would operate on different systems, different underwriting processes and parameters. All of these took a lot of time to solve for the marriage to happen.
• In the co-lending model, beyond technology challenges, the longevity of the relationship of Banks and NBFCs is a concern.
• The co-lending model is still in the nascent stages, and one may enter into an agreement, but over a period of time, the relationship should sustain.
• Most of these arrangements are with NBFCs that have sizable distribution but are low on capital. Most of the mid-sized well-rated NBFCs still opt for term loans over entering into co-lending models, given the complexities around integration and processes.

WHAT ARE THE OPPORTUNITIES?

• The co-lending model, if it takes off and is executed rightly, will ensure delivery of credit to the unserved and underserved.
• The real gap of credit exists with the segments such as small and medium businesses, credit to lower and middle-income groups, rural areas, etc.
• The opportunity can be taken up by digital lending start-ups and mid-size NBFCs, and they can actually marry their strength of distribution with bank’s funds.
• As banks are flushed with funds, they can cater to vast customers as NBFCs have reached in tier-3 and tier-4 cities. On the execution side, it really needs to be tested at ground level.

RISK IN CO-LENDING

• The move by big banks to tie up with small NBFCs for co-lending has come in for criticism from several quarters.
• Under the CLM, NBFCs are required to retain at least a 20 per cent share of individual loans on their books. This means 80 per cent of the risk will be with the banks — who will take the big hit in case of a default.
• The terms of the master agreement may 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.
• Interestingly, the RBI guidelines provide for the NBFCs to be the single point of interface for customers and to enter into loan agreements with borrowers, which should lay down the features of the arrangement and the roles and responsibilities of the NBFCs and banks. In effect, while the banks fund the major chunk of the loan, the NBFC decides the borrower.

CAN CHANGES IN THE CO-LENDING MODEL EASE CREDIT AVAILABILITY FOR THE PRIORITY SECTOR?

Though, direct assignment in a co-lending model typically with a bank calls for various critical challenges, as below.

COMPLIANCE WITH DIRECT ASSIGNMENT GUIDELINES

• The co-lending model requires that the taking over bank shall ensure compliance with all the requirements of direct assignment guidelines except the Minimum Holding Period (MHP) requirement.
• In a traditional direct assignment transaction, the direct assignment happens for a pool of assets through execution of an assignment deed, payment of stamp duty on the deed, seeking legal opinion on true sale, among others.
• Replicating the same in co-lending would mean the execution of assignment deeds for each customer, payment of stamp duty on a case-to-case basis and so on.
• This will not only increase the documentation/ procedures but also add to the cost of lending to the end borrower.

SECURITY CREATION AND RECOVERY

• The co-lending model very conveniently mentions that the co-lenders shall arrange for the creation of security and charge as per mutually agreeable terms and same for monitoring and recovery too.
• The bank which is to typically own a larger share in the exposure, would want the security to be created in its name.
• The loan is getting disbursed by the NBFC, and the security is created before even knowing the bank’s decision on its participation. It is not practically possible to create security in the name of a bank.

TAKEOVER OF LOAN AND CREDIT ENHANCEMENT

• The transaction in the co-lending arrangement involving post disbursal takeover of the bank’s share in the loan is akin to direct assignment, and the cases will be sourced as per the pre-agreed parameters.]
• Banks still want to do a 360-degree diligence within their internal policies while cherry-picking the loans and tend to follow an ideal co-origination approach.
• PSUs have always been unconvinced about the processes and practices of NBFCs.

Bottom line: Despite its multiple operational challenges, the direct assignment mode of co-lending has done justification in drawing a lot of confidence amongst the banks. The attributing factor is the familiarity of its structure and practical aspects. Riding on the same, combined with the greater objective of leveraging the collaborative efforts effectively towards financial inclusion, would certainly garner positive results in the time to come.

THE WAY FORWARD:

• To address the huge credit gap, the co-lending model is one of the right ways to go forward, but challenges around tech integrations and ground-level executions should be addressed.
• The country’s largest lender, SBI, it is actively looking at co-lending opportunities with multiple NBFCs / NBFC-MFIs for financing farm mechanisation, warehouse receipt finance, farmer producer organisations (FPOs), etc., for enhancing credit flow to double the farmers’/individuals’ income.
• The bank entered into a co-lending agreement with Vedika Credit Capital Ltd (VCCL), Save Microfinance Pvt Ltd (SMPL) and Paisalo Digital Ltd (PDL); it is a good move.
• Finance Minister Nirmala Sitharaman in visited to Mumbai in August to meet MDs of PSU banks. The focus should be towards credit growth to support MSMEs and underserved segments.
• The necessity of making the co-lending model work to enhance affordable credit to MSME and retail sectors.
• As the economy recovers coupled with pent-up demand, these kinds of models will evolve and grow to fulfil the credit requirements of the priority sector segments.

THE CONCLUSION: The co-lending model is a necessary step to help the priority sector. Though it has many challenges, it brings confidence in India’s banking sector that is much needed to address the challenges in a pandemic time. The collaboration is an effective effort for financial inclusion would certainly garner positive results in the time upcoming time.