In 2018, the Reserve Bank of India (RBI) announced guidelines around the “co-origination of loans” by banks and Non-Banking Financial Companies (NBFCs). Then in 2020, RBI amended these guidelines and introduced the term “co-lending model (CLM)”. With these announcements, RBI signalled its intention to push for more lending to priority sectors, such as MSMEs, agriculture, renewable energy, and housing.
Co-lending or co-origination is a lending model in which banks and NBFCs jointly contribute credit for priority sector lending (PSL). Under the arrangement, the lenders pool their resources to provide joint loans to more customers in more locations and at cheaper rates.
CLM makes affordable credit available to unserved and underserved borrowers, thus eliminating credit shortages and increasing financial inclusion in India.
Per RBI requirements, both CLM partners agree to split the loan and any resultant risk in a 80:20 ratio . But the risk/reward split is just one aspect of this 80:20 golden rule. There are three other key aspects that many borrowers are unaware of. Let’s explore these aspects in detail.
The 80:20 Split in Co-lending
As per RBI guidelines, originators have to maintain at least 20% of CLM loans in their books. The banks are to contribute to the remaining share.
This setup is RBI-approved because banks have access to a larger and cheaper source of funds that they can extend as credit. In this system, NBFCs assume the role of a consumer-facing entity, taking care of loan sourcing, customer experiences, and customer reporting through prior information-sharing agreements with their banking partner.
The 80:20 ratio also applies to loan risk and return, with banks assuming 80% of the risk and NBFCs assuming 20% by way of direct exposure. Since the bank takes on the lion’s share of the risk, it will also take the bigger hit if the borrower happens to default. But the bank also gets the larger share of returns when the borrower honours their commitment.
Now let’s explore the three key aspects of co-lending that many originators and even the other entities in the CLM ecosystem are unaware of.
1. Operational expenditure for a CLM loan
Origination is the first stage of the loan servicing process and includes borrower pre-qualification, loan application and processing, underwriting, credit decision, and finally, funds disbursal.
In a CLM partnership, the NBFC manages the origination process as the originator while the bank is known as the lender. Once the NBFC originates the loan, the bank can either take its share of the loan on its books or reject some loans after undertaking due diligence, even after the NBFC has done loan origination.
Regardless of which choice the bank makes, the NBFC retains its role as a loan originator and the single point of interface for borrowers. It is also responsible for loan servicing and payment recovery.
To execute these activities for each CLM loan, the NBFC incurs certain operational expenditures. It is the NBFC’s responsibility to manage and execute these expenditures. It must also look for opportunities to optimize them, to maintain healthy revenues and profits.
2. The Rate of Interest
RBI’s 2018 circular Co-origination of loans by Banks and NBFCs for lending to priority sector states how CLM partners should offer interest rates to borrowers. For fixed-rate loans, they should offer a single “blended” interest rate throughout the life of the loan. For floating-rate loans, they must offer the weighted average of the benchmark interest rates in proportion to their respective loan contributions.
Both CLM partners also have the freedom to price their part of the exposure as per their respective risk appetites and borrower assessments.
In general, NBFCs charge higher interest rates to counter their higher risk appetites. Not all customers can take on such high-interest loans. Under the CLM, they can get loans at reduced interest rates and thus better fulfil their credit requirements. These lower rates also benefit both CLM partners.
Banks can access and serve a larger customer base than they would be able to do on their own, while NBFCs can extend loans at lower interest rates than their competitors to capture a bigger slice of the customer base pie.
3. Delinquency Reserves that Both CLM Martners Must Maintain
The delinquency rate refers to the percentage of loans that are past their repayment due date. This metric compares the percentage of overdue loans to the total number of loans to indicate the quality of the lender’s loan portfolio.
The lower the delinquency rate, the higher the quality of the loan portfolio, and vice versa.
All lenders accept some level of loan delinquency in their portfolios and also try to recover delinquent loans by working with collections agencies. But overall, they try to keep the delinquency rate as low as possible, because a high level can negatively affect their business, damage their reputation, and reduce profitability.
The RBI’s 2018 and 2020 circulars on co-lending do not specify the rules that banks and NBFCs must follow with respect to delinquent loans and delinquency reserves. Nonetheless, banks create their own “master agreement policies” for co-lending with NBFCs. These policies include guidelines to evaluate a potential partner’s delinquency levels and loan portfolio performance.
Some banks specify that the NBFC’s delinquency in the portfolio where co-lending is proposed should not exceed a certain percentage of the gross non-performing assets (GNPA) – usually 5%. Other banks set their own product-based triggers relating to delinquency levels.
In summary, joint loans via co-lending enable borrowers to access quick and cheap loans to meet their credit needs. This is an especially vital benefit for India’s priority sectors like MSMEs where the credit gap continues to be pretty large (Rs 20-25 lakh crores as of May 2022).
Over the coming years, digitisation will majorly drive the growth of co-lending in India. And platforms like Yubi Co.Lend will lead the charge. Co.Lend is India’s largest co-lending “marketplace” to forge seamless co-lending partnerships and facilitate hassle-free loan disbursals.
Through tech-enabled co-lending, Yubi Co.Lend empowers banks and NBFCs to disburse faster joint loans to more borrowers. It has already helped disburse loans worth INR 5000 crores+ to 10 lakh+ retail customers.
The CLM has a lot of potential. Yubi Co.Lend will provide some much-needed momentum to the system, creating win-win benefits for all stakeholders i.e. Lenders, Originators and the end Borrowers.
For India to stand head-to-head with the developed economies of the world, financial inclusion is a critical priority. And with CLM and Yubi Co.Lend, financial inclusion is well within our reach.