“Co-lending” – A New Trend in the Finance Market

Introduction

In recent years, lending by private fintech companies most commonly known as Non-Banking Financial companies (NBFCs) have been on the rise, with NBFCs in India lending to entities/individuals and companies since the year 1960.

NBFCs have recently become a savior to small start-up companies and Micro Small and Medium Enterprises (MSME’s). MSME’s and start-up companies that account for more than 70% of global employment and 50% of GDP form an integral part of India’s economic system. However, due to the impact of Covid-19, these small start-up companies and MSMEs had been majorly affected on account of lack of finances and a global economic slow-down.

Taking into consideration this scenario, the Government of India, through the Reserve Bank of India (RBI), revised its earlier guideline of 2018 by issuing a fresh guideline on “Co-Lending by Banks and NBFCs to Priority Sector” vide circular FIDD. CO. Plan. BC.No.8/04.09.01/2020-21 dated 05/11/2020, superseding its earlier circular.

The Key Highlights of the Guidelines

Co-lending is a joint contribution of credit/loans by Banks and NBFCs at facility level with the sharing of risks and rewards. RBI in revising its guidelines, placed greater focus on the inflow of credit to the unserved and underserved sectors of the economy (more specifically the “Priority Sector”). The objective of the guideline is to make funds available to the ultimate beneficiary at an affordable cost considering the lower cost of funds from banks and greater reach of NBFCs.

Using this new “Co-lending Model” (CLM), banks are permitted to co-lend with all registered NBFCs (including HFCs) based on a prior agreement, which has been formulated in line with RBI guidelines.

Usually, the banks may enter into a Master agreement with eligible NBFCs with details including terms and conditions of the arrangement, criteria for selection of partner institutions, specific product lines and areas of operation, provisions related to segregation of responsibilities, customer interface, protection issues etc. The master agreement may provide for banks to either mandatorily take a share of the individual loans originated by the NBFCs in the bank’s books as per the terms of the agreement, or to retain the discretion to reject certain loans after due diligence prior to taking into its books.

It is evident that the CLM mainly depends on NBFCs to source reliable borrowers for the bank. The RBI has also made it clear that NBFCs are required to have a minimum of 20% share of the individual loans on their books at all times and 80% of the loan shall be deployed to the bank. The underwriting, the guarantee and the risk return shall also be done in the same 80%-20% ratio between the bank and the NBFC.

It is important to note that the interest rate shall be a combination of the average cost of capital plus their respective commissions, which usually lies between the interest rate charged individually by the bank and the NBFC. In the end, the roles and responsibilities of both the bank and NBFC shall be defined in a co-lending agreement. Generally, the NBFC shall be responsible for sourcing the customers, simple paperwork and the banks shall bring in cheaper funds and credibility.

Another important aspect to the guideline is that under the CLM, the bank and the NBFC are required to obtain prior approval of the board setting out a framework of the roles and responsibilities of both bank and NBFCs before entering into any agreement. The framework shall be in compliance with the RBI circular specifying details to be incorporated into the agreement. This board approval shall be the foundation to any master agreement to be entered into between the banks and NBFCs.

One final notable aspect of the circular is that it requires that all transactions with each individual borrower (including disbursements/ repayments) under the CLM to be routed through an escrow account maintained by both the banks and NBFCs. Such escrow arrangement will also be set out in the detailed understanding between the parties in relation to the operation and maintenance of such accounts.

The circular provides for roles and responsibilities of both the NBFCs and Banks, wherein the NBFCs shall be the single point of contact with the individual borrowers and the responsibility of servicing and the collection of payments is placed on NBFCs. The banks in turn shall appoint NBFCs as service agents, responsible for the collection of monies from the borrowers and depositing in escrow accounts on or before the relevant due date.

Conclusion:

Co-lending has come a long way, specifically recognized by the RBI via the implementation of a proper guideline and laying out the procedure for CLM.

This new system is definitely here to stay as it shall not only benefit startup companies and MSMEs, but it will also help in keeping the economy of the country stable. The double partnership of banks and NBFCs, wherein NBFCs having wider customer reach and integration of technology and banks having creditability shall open new avenues for many new companies. A slew of start-ups and banks have already started collaborating with each other in lending to niche segments of the economy and its likely that we will see tech-powered product innovation and loan books to increase in times to come.