Bank-NBFC Co-lending

In News

• A 2020 decision by RBI to permit banks to “co-lend with all registered NBFCs based on a prior agreement”, has led to unusual tie-ups like the one announced recently between the State Bank of India and Adani Capital.

About

• Several banks have entered into co-lending master agreements with NBFCs, and more are in the pipeline.
• SBI 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.

‘Co-Lending Model’ and its Features

• Meaning: Under CLM, banks are permitted to co-lend with all registered NBFCs (including HFCs) based on a prior agreement. The co-lending banks will take their share of the individual loans on a back-to-back basis in their books.
• Lending to the priority sector: In 2018, the RBI had announced “co-origination of loans” by banks and Non-Banking Financial Companies (NBFCs) for lending to the priority sector.
• Retain a minimum share: The RBI has clearly said that NBFCs shall be required to retain a minimum of 20 percent share of the individual loans on their books.
• Greater operational flexibility: To better leverage the respective comparative advantages of the banks and NBFCs in a collaborative effort, the central bank allowed the lenders greater operational flexibility, while requiring them to conform to regulatory guidelines.
• The risks and rewards of co-lending: will be shared among the borrowers to the extent of their individual exposures.
• Not applicable to foreign banks: The CLM shall not be applicable to foreign banks with less than 20 branches.
• Joint approval: Both the lenders were supposed to approve a case before disbursement and jointly contribute to the exposure at facility level.

Structure of the co-lending

• The lenders have two options to choose to structure their co-lending products on the bank’s part:
  • Pre-disbursal contribution: to a loan under a mechanism for ex-ante due diligence.
  • Post disbursal takeover: Of banks share in the loan on a back-to-back basis.

Issues/ Challenges

• Risk will be with the banks: NBFCs are required to retain at least a 20 per cent share of individual loans on their books. This means 80 per cent of the risk will be with the banks who will take the big hit in case of a default.
• NBFC decides the borrower: RBI guidelines provide for the NBFCs to be the single point of interface for customers, and to enter into loan agreements with borrowers, which should lay down the features of the arrangement and the roles and responsibilities of the NBFCs and banks.
  • In effect, while the banks fund the major chunk of the loan, the NBFC decides the borrower.
• Corporatism in banking: While the RBI hasn’t officially allowed the entry of big corporate houses into the banking space, NBFCs mostly floated by corporate houses were already accepting public deposits. They now have more opportunities on the lending side through direct co-lending arrangements.
  • This has come at a time when four big finance firms IL&FS, DHFL, SREI and Reliance Capital which collected public funds have collapsed in the last three years.
• Reach of banks is far wider than small NBFCs: While the RBI has referred to “the greater reach of the NBFCs”, many bankers point out that the reach of banks is far wider than small NBFCs with 100-branch networks in serving underserved and unserved segments.
• Turn-around time of banks for approvals is much longer: Even though the credit parameters are predefined between the co-lenders, the turn-around time of banks for approvals is much longer than NBFCs which blunts the sharpness/ competitiveness of the model.
• Security creation and recovery: Co-lenders shall arrange for creation of security and charge as per mutually agreeable terms and same for monitoring and recovery too.

Significance

• A collaborative effort: The idea is banks have the money and lower cost of funds while NBFCs have greater reach on the ground. “This is a brilliant initiative to push credit to economically weaker sections.
• Loans at a very affordable rate: The benefit of such a co-lending scheme was that the end borrower shall get loans at a very affordable and competitive rate because of the lower cost of funds from banks and greater reach of the NBFCs.
• Boon to economically weaker section: Improve the flow of credit to the unserved and underserved sector of the economy.
• Last mile banking services: To enhance last-mile finance and drive financial inclusion to MSMEs by offering secured loans.
• Growth of India’s farm economy: Help to expand customer base as well as connect with the underserved farming segment of the country and further contribute towards the growth of India’s farm economy.
• Better records on book: NBFCs can get bigger and top rated borrowers on its books through this arrangement, which wouldn’t have been possible otherwise.

Way Forward

• Not a new idea: Co-lending didn’t take off earlier because if the loan proposal is good, lending institutions are reluctant to share it with other lenders. If the borrower quality is bad, it is difficult to find a co-lender.
• Credit is a function of demand: Co-lending is unlikely to work in a big way since credit is a function of demand and joint-lending is not really a new idea.
• Will they really share their borrowers: Banks have the money; NBFCs have people on the ground. This partnership makes sense. But, the key question is why would a bank share a good borrower with an NBFC.

Source: IE