India’s evolving Co-Lending model is already creating huge benefits for borrowers and helping to close the enormous credit gap in many sectors to which NBFCs in India lend. Co-originated loans promote financial inclusion in the country through better reach, democratic credit access, and relatively competitive interest rates. Equally important, the securitisation of co-lending books is helping NBFCs to meet their funding requirements, thus keeping the credit cycle rolling.
Funding Challenges for NBFCs in India
Large, well-governed, and high-rated NBFCs have relatively better access to bank funding and the debt markets and create adequate liquidity buffers. However, smaller NBFCs don’t have it easy, especially in the post-COVID era when the market started differentiating even more between highly-rated NBFCs and others, thus making funding access harder for the latter.
Declining collections across asset classes and segments and increasing proportions of stressed assets have also added to smaller NBFCs’ liquidity problems. In Q1 FY22, larger, well-established NBFCs experienced a doubling of bad loans, creating liquidity crises. The problem is worse for smaller NBFCs because increased delinquencies hit them much harder, and they do not enjoy relatively easier & cheaper access to capital, unlike the larger NBFCs.
The RBI’s new tighter provisioning norms – applicable from 1st October 2022 – could also lower liquidity for NBFCs as they would have to set aside more funds (0.25% – 2% for standard assets) as provisions. In April 2020, the RBI announced its Targeted Long Term Repo Operations 2.0 (TLTRO) to channel more liquidity to NBFCs and to “engender conducive financial conditions and normal functioning of financial markets and institutions.” RBI mandated that banks availing funds in TLTRO 2.0 must invest at least 50% of availed liquidity in small and mid-sized NBFCs. Unfortunately, banks have responded poorly to the scheme, which has made NBFCs’ liquidity problems worse.
The absence of refinancing options also hampers credit flow for NBFCs in India. A refinancing window for NBFCs could help them minimise their liquidity problems. Securitisation of loan books is another way for NBFCs to parry the liquidity crunch.
What is Co-Lending?
Co-lending model a joint lending process involving two ﬁnancial institutions – a large lending institution, like a bank or an NBFC (Investor), and a relatively smaller NBFC or a fintech (Originator) – come together to give loans to the priority and non-priority sectors and bridge the credit gap in the country. In this process, an originator utilises its technology, underwriting expertise, and geographical reach to locate credible borrowers in the priority sector and collaborate with a Bank to underwrite and disburse a joint loan.
Joint lending addresses customers’ needs with risk and reward-model throughout the life cycle of a loan. This model takes advantage of the bank’s lower cost of funds and the NBFCs’ greater reach, reducing the overall cost of debt to the borrower.
What is Securitisation?
According to the RBI’s securitisation framework, securitisation involves “transactions where credit risk in assets are redistributed by repackaging them into tradable securities with different risk profiles which may give investors of various classes access to exposures which they otherwise will be unable to access directly.”
Simply put, securitisation means pooling assets so they can be repackaged into interest-bearing securities. Anyone who purchases these securities (“investor”) gets the interest and principal payments from the original assets. Securitising assets turns them into tradeable, fungible items with some monetary value. The process creates investment opportunities for investors and promotes liquidity to the originating NBFC, which can further use the securitisation proceeds to on-lend.
While almost any financial asset with a stable cash flow and a healthy financial performance can be securitised; securitisation usually occurs with assets that generate receivables. Good candidates for securitisation include asset-backed loans, mortgage-backed loans, home loans, auto loans, consumer loans, and trade receivables.
The Benefits of Securitisation of Co-lending Books for NBFCs
The securitisation of co-lending books can enhance credit access for NBFCs. By borrowing against the assets to refinance their origination, NBFCs can tap new sources of funding. Securitisation can also help NBFCs to free up capital, increase capital efficiency, lower their borrowing costs, and to some extent, lower their regulatory minimum capital requirements.
In general, securitisation can drive the growth and development of NBFCs, which the RBI also recognises. The securitisation framework aims to permit more investors, such as mutual funds, to invest in NBFCs’ securities. thus resulting in deepening of the securitisation market, and creating more tradable securities as compared to conventional loans.
Operational and Legal Aspects of Co-lending Securitisation in India
The securitisation of co-lending records involves several aspects that many NBFCs are unfamiliar with. For one, the co-lending partners each hold some portion of the receivables from the underlying loans according to the co-lending contract. Therefore, the partners can only securitise their share in the borrower payments that contractually belong to each.
Further, the securitised receivables must be “bankruptcy remote,” An entity must be formed to develop the co-lending project, isolate financial risk, and minimise bankruptcy risk for the co-lending partners. Here’s where entities like SPVs and SPEs come in. Since SPEs are bankruptcy remote, the transferred and securitised assets are beyond the originator’s and creditors’ reach.
Finally, co-lending arrangements between banks and NBFCs may involve first-loss default guarantees (FLDGs). The FLDG is meant to compensate the partners for losses that may occur in case customers fail to repay. In other words, assigning and operationalising FLDGs to the securitisation trust could allow partners to absorb losses in the event of loan delinquencies.
The Future of Co-lending and Securitisation
In the coming years, the securitisation of co-lending books will support the growth of NBFCs by opening up new funding routes for them. Securitisation will allow NBFCs to deploy funds in high-yielding co-lent loans that could be released over the short-term, thus minimising their liquidity challenges. In addition, securitisation will improve the quality of co-lent loans and increase market confidence regarding the norms governing co-lending arrangements between banks and NBFCs in India.