Co-lending can be just what the doctor ordered to improve the flow of credit to unserved and underserved sectors of the economy at an affordable cost, through the wave of reconciliations between banks and financial companies non-banks (NBFC) in recent months. Top bankers and NBFC chiefs say the co-lending model (CLM) is a win-win proposition for banks, NBFCs and their customers.
The Reserve Bank of India (RBI) had issued a Circular to Regular Commercial Banks (Excluding Small Financial Banks, Regional Rural Banks, Urban Cooperative Banks and Local Banks) on CLM on November 5, 2020, with a view to d better leverage the comparative advantages of banks and NBFCs in a collaborative effort with respect to all categories of lending to priority sectors.
Given the emerging tensions in micro, small and medium-sized enterprises (MSMEs), it is possible that once the Emergency Credit Line Guarantee Scheme (ECLGS) ends on March 31, 2022, bankers will become more circumspect in regarding loans to MSMEs. But co-lending links can ease any concerns they might have about lending to MSMEs.
The ECLGS provides 100% guarantee cover from the National Credit Guarantee Trustee Company to certain borrowers. Banks have restructured 24.51 lakh MSME accounts totaling ₹1,16,332 crore since January 2020 as a result of the pandemic, according to RBI data. There is uncertainty about how these accounts will perform during the third wave of the pandemic. Thus, banks can overcome their risk aversion through co-lending partnerships with NBFCs, which have proven prowess in sourcing, underwriting, disbursing and recovering loans.
CLM is based on the symbiotic relationship between banks and NBFCs. The lower cost of funds for banks and the greater reach of NBFCs should benefit borrowers. Under the CLM, NBFCs are required to keep a minimum 20% share of individual loans on their books, with the balance held by banks. It is the medium and small-sized NBFCs with a rating below “AA”, which have a relatively higher cost of funds, that make reconciliations with banks.
However, large ‘AA’ and ‘AAA’ rated NBFCs, which can access low-cost resources in the market, see no particular benefit in partnering with banks. “NBFCs are more efficient in sourcing, lending and collecting. What they lack is the cheaper source of funding that we have. So the partnership (between banks and NBFCs) is a win-win,” said Rajkiran Rai G, MD and CEO, Union Bank of India, at the FICCI-IBA (FIBAC) conference last month.
But making CLM successful is a big challenge because there are several issues – banks’ balance sheet-based lending model versus NBFC’s cash flow-based lending model; Evaluation; eligibility criteria (for example, related to income); etc – which need to be addressed. “We focus more on policies and have very rigid filters. So you (the borrowers) have to adapt to this, only then will you get a loan.
While NBFCs are more receptive to change/flexibility flexible. “We are more data-driven whereas NBFCs are more practical. So they look at a store, the steps, the cash flow and decide that the customer can repay and can take the risk. This is the basic difference between NBFCs and banks,” Rai explained.
The head of Union Bank pointed out that his bank is developing products, which are a hybrid between a pure banking product and a pure NBFC product, suitable for co-lending. Rai pointed out that co-lending cannot be done through a traditional branch, which offers traditional credit products, because the mindset of staff will be a big issue.
“So we have created a separate branch and a separate team, which is specially trained to sanction loans under the CLM. “…the ultimate beneficiary will be the customer because he will get money easily and at the right price. Everyone is positive about this model. We can build on that,” Rai said.
Financial industry expert PH Ravikumar noted that when banks consider co-lending, they look at NBFCs which on a monthly basis generate a decent amount relevant to their balance sheet. “If you take, for example, State Bank of India, Bank of Baroda, ICICI Bank and HDFC Bank, if an NBFC makes a monthly issue of less than ₹100 crore, it makes no difference to its balance sheet.
“When it comes to microfinance or MSMEs, the ability of specialized NBFCs to spot, manage and contain risk is much better than that of large banks. NBFCs have the skills, the local focus and the local intelligence. Apart from a structured approach, physical touch and feel are also important in assessing credit,” he said.
Thus, the co-loan becomes more and more important provided that there is a minimum monthly origin. Ravikumar said banks therefore extend lines of credit to NBFCs, become familiar with them and understand their ability to generate, manage and contain risk. And as soon as they are comfortable with that, they move on to co-lending.
Prashant Kumar, MD and CEO, YES Bank, observed that in a very short time (just six months), his bank was able to fully implement co-lending partnerships with three major NBFCs. “And every month we add nearly ₹300 crore…And we have clear visibility, by which we could do something around ₹1,000 crore per month,” Kumar said.
Advantage of the co-loan
Shachindra Nath, Executive Chairman and Managing Director of U GRO Capital, pointed out that the advantage of co-lending is that the bank knows that even if it uses NBFC intermediation, its ultimate exposure is not to NBFC. but to an end customer. “Over the next couple of years, co-lending (on the data tripod of GST, bank and bureau) will become the mainstay of providing capital to the last mile through NBFC as an intermediary. And I have no doubts about that,” he told FIBAC.
Nath believes that collaboration between large banks and niche NBFCs/fintechs, in which lending as a service (LaaS), would become a leading force. The Boston Consulting Group (BCG), in a recent report, stated that due to adverse selection, public sector banks (PSBs) have had an extremely poor leverage experience in small business financing, which led to a decline in their growth and a loss of relevance in this important segment.
PSBs would particularly benefit from partnerships with third-party platforms and NBFCs/fintechs with last-mile reach, he added. The global consultancy is of the view that CLM needs to be re-imagined as an open digital marketplace rather than a cumbersome one to operationalize an NBFC contract between a bank to bridge the last mile. In its current form, as an individual agreement, it is very cumbersome and slow to implement,” BCG said.
The company observed that RBI should reinvent co-lending as an extension of the Open Credit Enablement Network (OCEN) framework in the area of secured lending with standardized protocols for a range of issues ranging from credit reporting, accounting , NPA recognition, security creation and enforcement, among others. The First Loss Default Guarantee (FLDG) is a powerful catalyst for partnerships.
“We need to institutionalize a regulatory framework to establish FLDG by lending Service Providers (LSPs) to a lender with the provision of appropriate compulsory regulatory capital to support it. A separate NBFC (FLDG) license may be created for the specific purpose of regulating this LSP,” the BCG recommended.
January 17, 2022