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With a population surpassing 1.4 billion, India encompasses a diverse landscape of 28 states and 8 union territories. Nearly 65% of the population lives in rural areas and a significant part still remains disconnected from the realm of formal financial services. Driving higher financial inclusion, a vital objective of economic growth, hinges on expanding affordable credit access to EWS (economically weaker sections), LIG (low-income groups), and MIG (medium-income groups) to cater specifically to their needs. Several factors contribute to the limited penetration of financial services and hamper the transition to branchless banking in these segments, including a lack of trust and attachment to conventional banking mechanisms.

The need to bridge the gap is not limited to the retail segment alone. The priority sector (including agriculture, the micro, small, and medium enterprise (MSME) segment, and other critical segments) also needs a strong growth impetus. The MSME sector forms the backbone of India’s economic structure, accounting for approximately 33% of the country’s total GDP, and is expected to contribute US$1 trillion to India’s total exports by 2028, as per recent data. Yet, most MSMEs do not have access to the liquidity required for their daily working capital needs. The Reserve Bank of India has been conscious of this gap and has made policy changes, of which the Co-lending Model forms a major component. The adoption of formal financial service channels such as digital lending and payments is a slow transition in the priority sector due to the preference for cash-driven models, but co-lending is gradually becoming a catalyst for change.

The emergence of the Co-lending Model (CLM)

The concept of co-lending has been around since 2018 as the erstwhile co-origination model. Under this arrangement, the RBI allowed the co-origination of loans by all scheduled commercial banks and Non-Banking Financial Companies (NBFCs) for lending to the priority sector. However, considering the challenges of inflexibility and under-utilization of the individual strengths of banks and NBFCs under this model, the RBI expanded the scope of the co-origination framework. Rechristened the ‘Co-Lending Model’ (CLM), it aimed to improve the flow of credit to the underserved and unserved segments of the economy, making loans available to them at an affordable cost.

Fintech companies and NBFCs usually have a wider target audience because of their customer-centric approach and the surge in the digital acquisition of potential customers, but they lack economical access to large funds to extend loans. On the other hand, banks have a larger pool of funds for extending credit but lack a holistic customer acquisition strategy that leverages digital penetration. Co-lending helps synergize the individual strengths of banks and NBFCs under one lender’s umbrella to deliver a comprehensive experience to all stakeholders.

Provisions of a co-lending arrangement

The RBI has defined the framework to make this model work for achieving financial inclusion and widening credit access. Some of the terms of the RBI’s co-lending arrangement are explained below.

Banks and NBFCs will co-lend based on a prior master agreement. This agreement will define the terms and conditions of the arrangement, criteria for selecting partner institutions, products offered, and segregation of responsibilities pertaining to customer interaction and protection issues.

As per the 80:20 split, the RBI mandates NBFCs to retain a minimum of 20% share of the individual loan value on their books. This enables banks, who have greater access to demand deposits, to source the majority of the capital.

For issues pertaining to customer service, NBFCs shall be the single point of contact for the members of the priority sector. They shall enter into an agreement with the borrower, highlighting the terms of the loan, the responsibilities of the bank and the NBFC, and all the details of the arrangement so that customers are fully informed and provide explicit content.

The interest rate levied on the borrower shall be all-inclusive, as agreed upon by both lenders at the time of creating the master agreement.

Information sharing should be transparent and agreed upon between the two lenders, and the NBFC shall be responsible for generating a single unified statement for the customer.

With respect to grievance redressal, the co-lenders shall come to an agreement that allows the resolution of any borrower complaint registered with the NBFC within a period of 30 days, failing which the borrower can escalate the same with the banking ombudsman or any other official, as may be applicable.

The bank and the NBFC entering into the agreement shall implement a business continuity plan to ensure uninterrupted service to their borrowers till repayment of the loans under the co-lending agreement in the event of termination of the arrangement between the co-lenders.

The benefit to borrowers and the lending ecosystem

Borrowers benefit immensely from the co-lending arrangement. With banks on board, the benefits of lower interest rates and a convenient disbursal process are passed on to the borrowers. Additionally, communities that are credit-deprived or do not have extensive credit histories can also gain access to formal loans from banks. NBFCs in the co-lending arrangement go the extra mile to educate customers about the terms and conditions of the contract, contributing to financial literacy in underserved segments as well.

As a result of the agreement made with banks, NBFCs can leverage the arrangement to extend loans at a lower interest rate, which is otherwise not possible owing to the high risk of default in the borrower segment they serve. Being associated with established banks lends credibility and stability to the NBFCs and enhances borrower trust. Banks, on the other hand, are able to gain a wider reach in the remote geographies of the country, embrace digital acquisition, and interact with the underserved segments of the population. Conversions and repeat lending have become possible since NBFCs focus immensely on customer-centricity as their main goal. The division of risk as a result of the collaboration is an added benefit to both co-lenders.

Co-lending: Unlocking possibilities for financial inclusion and economic growth

The co-lending model has the potential to change the game because of the crucial role the priority sector has played in advancing financial inclusion and the overall growth of the economy. Co-lending has enormous potential for closing numerous gaps currently preventing the priority sector’s growth. The following section discusses some of the ways that co-lending is enhancing initiatives to increase financial inclusion.

Resolving the challenge of liquidity: Owing to the conservative lending approach in banks, liquidity in the priority sector has remained a challenge. While NBFCs have the reach, they lack the liquidity needed to bridge the gap. As per RBI data, bank credit grew by 15% YoY in the fiscal ending March 2023, with bank advances rising to INR 136.75 lakh crore as on March 24, 2023, from INR 118.91 lakh crore as on March 25, 2022. These numbers highlight the potential for growth in India’s banking sector, underscoring the importance of including banks in the meaningful expansion of credit. The co-lending model acknowledges that banks dominate vast liquidity reserves and presents an opportunity to leverage this untapped potential.

Solving the problem of systemic risk: The co-lending model allows NBFCs to use their capital efficiently. Collaborating with a bank allows them to scale products with a good product-market fit. Additionally, the problem of systemic instability in the financial system can be addressed since both NBFCs and banks are regulated bodies. Thus, the CLM ensures that products and processes do not run into compliance issues. Making the financial ecosystem insulated against risks contributes to the stabilization and growth of lending entities.

Leveraging tech for credit and collection: On the one hand, co-lending allows credit access to a higher number of individuals and business entities served by NBFCs. On the other hand, banks are able to utilize technology for onboarding, risk assessment, and debt collections. The use of data in back-end operations, automation of KYC processes, electronic documentation, and other such capabilities ensures seamless credit flow to the underserved. Put simply, banks are able to extend credit to borrowers they would have otherwise rejected, leading to greater financial inclusion.

Co-lending and the need for a streamlined lending and collections ecosystem

It is important to note that the overall efficacy of the co-lending model depends upon the achievement of KPIs such as accuracy in risk assessment, lower cost of lending, higher operational flexibility, seamless compliance, and a convenient repayment schedule. Put simply, a digital journey for faster disbursals and ease of reconciliation is essential for the co-lending model to succeed. The widened access to credit that benefits more segments presents an opportunity for the deployment of end-to-end debt collections processes. A robust digital stack can augment co-lenders’ efforts to create paperless and seamless collections platforms that reduce processing time while catering to the specific needs of underserved segments.

The rapid adoption of digital lending platforms is an exemplary use case to understand the benefits of digitization in the underserved geographies of India. Additionally, the vast number of government-led lending initiatives to improve credit flow through digitization in the priority sector is resulting in a swift increase in loan book values. To keep NPLs within range, banks and NBFCs will benefit from deploying debt collections platforms that automate data analysis, customer engagement, and all subsequent processes throughout the life cycle of debt. The use of predictive analytics to analyze borrower behavior is a useful tool to enable co-lenders to take timely measures for debt recovery while delivering a smooth borrower experience.

The future of co-lending

Co-lending has come a long way over the past few years and reflects the intent of the RBI to drive financial inclusion through affordable and easier access to credit at the grassroots level. Top public and private sector banks such as Punjab National Bank, Yes Bank, State Bank of India, and Bank of India have collaborated with leading NBFCs over the years since the launch of the model. According to a report, banks and NBFCs could sign co-lending deals worth INR 1 trillion in FY24 after public sector banks alone declared a co-lending portfolio of INR 254 billion for FY23.

With the digital divide narrowing at an unprecedented pace, India is poised to resolve its liquidity issues faster than usual. The encouraging structural ecosystem is a boost for financial players to come together to meet the rising demand for credit. Co-lending will undoubtedly develop into the catalyst the financial industry needs to uplift the priority sector from its current and potential economic hardships as the model matures and efforts are made to implement it as the RBI intended.

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