Co-lending, also known as co-origination, is a system in which banks and non-banking financial companies collaborate to provide credit to the priority sector participants. Under this arrangement, banks and NBFCs share risk in an 80:20 ratio (80 % of the loan with the bank and a minimum of 20% with the non-banks).
The Reserve Bank of India has devised a Co-Lending Model (CLM) program where banks and NBFCs work together to provide loans to priority sector borrowers on a pre-agreed basis. The RBI launched the co-origination of the loan program in September 2018, which was updated in 2020 and renamed the “Co-lending Model.” It intends to provide all lending institutions with more freedom.
According to RBI guidelines, a minimum of 20% of credit risk from direct exposure must be held by the NBFC till maturity, with the remainder owned by the bank. When the loan matures, the bank and the NBFC split the interest payback or recovery according to their credit and interest share.
Because of this dual origination, banks can claim priority sector status for their portion of the credit. Customers interact with NBFCs through a single point of contact, and a tripartite agreement is reached between customers, banks, and NBFCs.
Let’s learn more about the RBI’s Co-Lending Model Guidelines for Banks and NBFCs.
What is the Co-Lending Model?
In 2018, the Reserve Bank of India (RBI) released the co-origination framework, allowing banks and non-bank financial companies to co-originate loans. In 2020, the rules were revised and renamed co-lending models (CLM) to include Housing Finance Companies and other adjustments to the framework.
CLM’s primary goal is to increase credit flow to the unserved and underserved economy segments at a reasonable cost. Banks have cheaper funding costs, and NBFCs have a more extensive reach outside tier-2 and tier-3 cities.
Why has it taken so long for Co-Lending to gain traction?
The Ministry of Finance has pushed PSU banks to use co-lending schemes on multiple occasions. In the beginning, some PSU banks partnered with large non-banking institutions. In September 2019, for example, SBI partnered with ECL Finance, a subsidiary of Edelweiss Financial Services.
However, several of these collaborations did not pan out as planned. According to bankers, both banks and NBFCs are receptive to such collaborations, but the difficulty lies in the execution on the ground.
As both banks and NBFCs would operate on various systems, underwriting processes, and characteristics, IT integration of systems was one of the most significant obstacles.
What is the RBI’s notification on the Bank-NBFC Co-Lending Model?
RBI RBI/2020-21/63 passed the notification on November 5th, 2020, FIDD.CO.Plan. BC.No.8/04.09.01/2020-21.
The primary goal of this circular is to:
- To improve credit flow to the unorganized and underserved sector of the economy
- To enable access of funds to the ultimate beneficiary at affordable rates
- To strengthen the relationship between banks and NBFCs regarding lending to the priority sector.
- Adopting government techniques to achieve a proficient harmonization of loans in key areas.
- To help banks increase their reach by using the technology of NBFCs.
Priority Sector
The RBI considers the essential priority sectors of the economy to be those where timely and sufficient credit may be challenging to obtain. The following categories are included in the Priority Sector:
- Agriculture
- Housing
- Micro, Small, and Medium Enterprises (MSMEs)
- Export Credit
- Education
- Start-ups
- Renewable Energy
- Social Infrastructure
- Miscellaneous
What are the Co-Lending Model’s Guidelines?
The following are the critical goals of the Co-Lending Model:
1. Improvement in Credit Flow
The Indian government has proposed to help the country’s rural areas. The rural sector in India accounts for the majority of the population. As a result, the goal is to establish a steady flow of excellent credit in rural society, aiding in its growth and development.
2. Maximum Reach
Through the partnership, both non-banking financial companies and banks can benefit from each other’s strengths. The decreased cost of funding from banks combined with the NBFC’s wider reach will make low-cost funds available to the eventual recipients.
3. Generating Funds
The goal is to increase the availability of funds, particularly in rural areas, because obtaining loans from the public sector and financial institutions are sometimes difficult for those living in rural areas. As a result, banks have formed partnerships with these non-banking financial companies to generate funds for rural areas.
4. Sharing Risks and Rewards
Collaboration between banks and NBFCs would result in improved lending plans and the development of cutting-edge technology. However, it would also include sharing various types of risks and returns between banks and NBFCs, easing the pressure on them in the long run.
5. To Strengthen the Bond
This collaboration would strengthen the link between banks and NBFCs, that’s why the government has devised the co-lending model. This program allows both banks and NBFCs to achieve their objectives coordinated. The government has implemented several policies to strengthen the interaction between the NBFC and the bank.
What Characteristics Does the Co-Lending Model Have?
The Reserve Bank of India has implemented a co-lending scheme to improve and expand lending terms for both banks and non-banking financial companies. The following are the main characteristics of the co-lending model:
1. Systems
Banks and non-banking financial companies (NBFCs) must ensure that adequate systems are in place to implement anti-money laundering and due diligence measures.
2. Clients
Non-Banking Financial Companies are responsible for dealing with and negotiating with clients.
3. Master Agreement
Banks and NBFCs are mandated to enter into a master agreement. The terms and conditions of the agreement should include the arrangement’s terms and conditions, the criteria for selecting partner institutions, the specific product lines and areas of operation, segregation of responsibility provisions, and consumer interface and protection issues.
4. Warranties and Representations
All co-lending agreements must include representations and warranties that must be in accordance with the pre-negotiated terms and conditions between non-banking financial companies and banks.
5. Internal Audit
It’s critical to follow the bank’s and NBFC’s internal and external audit criteria for the types of loans they will provide under the co-lending plan.
6. Security
In the co-lending approach, the NBFC and the bank will jointly decide on the terms of security creation.
7. Business Continuity
The requirements of the co-lending agreement should have no impact on the usual business that banks and NBFCs do with their customers.
8. Approval
All information related to the co-lending model should be made available to clients and must be authorized by them. Customers can also file concerns with the Reserve Bank of India’s Customer Education and Protection Cell.
9. Loan Recovery
The co-lending plan would include the necessary provisions for recovering loans from clients.
10. Promoter Groups
Under this co-lending model, banks cannot participate in any other co-lending regime. The Non-Banking Financial Company is governed directly by a promoter group.
Conclusion
The Reserve Bank of India (RBI) has created the Co-lending model plan, which involves collaboration between banks and non-banking financial companies (NBFCs). As a result, all conditions in this agreement must be in accordance with what the parties have agreed to provide loans to priority sector borrowers based on the prior agreement. To learn more, get in touch with NBFC Advisory.
