Indian Economy
Bank-NBFC Co-lending
- 14 Dec 2021
- 5 min read
Why in News
Recently, several banks have entered into co-lending 'master agreements' with registered Non-Banking Financial Companies (NBFCs), and more are in the pipeline. In 2020, the Reserve Bank of India (RBI) allowed the co-lending model based on a prior agreement.
- However, there are some criticisms associated with the co-lending.
Key Points
- About the Co-Lending Model:
- Background: In September 2018, the RBI had announced co-origination of loans” by banks and NBFCs for lending to the priority sector.
- The arrangement entailed joint contribution of credit and sharing of risks and rewards. Co-lending or co-origination is a set-up where banks and non-banks enter into an arrangement for the joint contribution of credit for priority sector lending.
- These guidelines were later amended in 2020 and rechristened as co-lending models (CLM) by including Housing Finance Companies and some changes in the framework.
- Under priority sector norms, banks are mandated to lend a particular portion of their funds to specified sectors, like weaker sections of the society, agriculture, MSME and social infrastructure.
- Objective: The primary focus of the ‘Co-Lending Model’ (CLM) is to “improve the flow of credit to the unserved and underserved sector of the economy.
- It also envisages making available funds to the ultimate beneficiary at an affordable cost.
- Underlying Idea: CLM seeks to better leverage the respective comparative advantages of the banks and NBFCs in a collaborative effort.
- The lower cost of funds from banks
- Greater reach of the NBFCs.
- For example, CLM will enhance last-mile finance and drive financial inclusion to MSMEs.
- Example of CLM: 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.
- Background: In September 2018, the RBI had announced co-origination of loans” by banks and NBFCs for lending to the priority sector.
- Risk in Co-lending:
- Majority of Responsibility Lies with the Banks: Under the CLM, NBFCs are required to retain at least a 20% share of individual loans on their books.
- This means 80% of the risk will be with the banks — who will take the big hit in case of a default.
- In effect, while the banks fund the major chunk of the loan, the NBFC decides the borrower.
- Corporates in Banking: While the RBI hasn’t officially allowed the entry of big corporate houses into the banking space, the NBFCs are mostly floated by corporate houses.
- This is risky, especially when four big private finance firms — IL&FS, DHFL, SREI and Reliance Capita have collapsed in the last three years despite tight monitoring by the RBI.
- Limited Reach of NBFCs: While the RBI has referred to “the greater reach of the NBFCs”, the small NBFCs with 100-branch networks will fall short in serving underserved and unserved segments.
- Majority of Responsibility Lies with the Banks: Under the CLM, NBFCs are required to retain at least a 20% share of individual loans on their books.
Way Forward
- There is a need to give greater powers to the bank's board in order to drive, review & oversight the decision-making process. And for that, the best talent must be recruited.
- Also, there is the requirement of a much stronger risk handling mechanism.
- The need is to now look at foreign markets, and set up appropriate business policies (in terms of the global location & the product these banks can target) that will help in increasing the efficiency and the competition of these banks with their global counterparts.
- Continuous reforms should be undertaken regarding,
- Product innovation,
- Investments in technologies,
- Better back-end processes,
- Reduction in turnaround time.