written by | January 2, 2023

Everything You Need to Know About Co-Lending Model and its Benefits

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Table of Content


India's socio-economic growth is significantly enhanced and ensured by the Micro, Small Medium Enterprises (MSMEs) sectors due to its contribution to the GDP and exports of the nation. The co-lending circular states that CLM primarily depends on NBFCs' capacity to find trustworthy customers so that banks can offer finance. In that sense, the RBI also seeks NBFCs with stakes in the outcome.

Additionally, the pandemic's prolonged nature has contributed to a global recession and historically high inflation rates. The co-lending circular states that CLM primarily depends on NBFCs' capacity to find trustworthy customers so that banks can offer finance. In that sense, the RBI also seeks NBFCs with stakes in the outcome. Therefore, the RBI has maintained that NBFCs must have a minimum of 20% of the personal loans on their books to comply with the co-origination structure.

SFBs are not currently allowed to co-lend with another borrower. To co-lend to key sectors including agriculture, micro, small and medium-sized enterprises (MSMEs), education, infrastructure, and others, only regulated commercial banks and NBFCs are permitted.

Did you know? One of the first NBFCs to co-lend with ICICI Bank in 2019 was SBFC (Small Business Finance), an NBFC that provides financing to small enterprises. Recently, more NBFCs and banks have started to expand their co-lending partnerships. Let's examine some of the co-advantages of lending now that its definition is apparent.

What is the Co-lending Model?

The idea of co-lending has been around for a while, but now that the RBI has established guidelines for the co-origination of credit, banks and NBFCs are collaborating to provide funding to the priority sector. While NBFCs have access, banks have the resources. Co-lending models allow traditional banks to lend significantly more money while utilizing the fintech business model for digital reach.

For both banks and NBFCs, a co-lending model seems beneficial because it will help close the lending segment's disparities. It is a successful model because it enables reliable technology to ease the operational difficulties associated with conventional lending methods. The joining of two lending companies to offer joint loans to clients is referred to as co-lending or co-origination. 

How does co-lending work?

It is a structure where the banking and non-banking sectors work together in an arrangement for the combined provision of credit for priority sector loans. It is a major component of the co-financing structure. This arrangement grants companies the authority to find clients, evaluate credit, and disburse a tiny portion of the loan amount. Following this structure, banks and NBFCs split risk 80:20, with banks bearing a minimum of 20 percent of the loan and non-banks such as NBFCs, HFCs, Fintech, etc. bearing a minimum of the remaining 80 percent. According to an ILO (International Labour Organization) survey, MSMEs produce 50% of the world's GDP and more than 70% of all jobs worldwide. The MSME sector, however, was among those most adversely affected by the Covid-19 outbreak and its associated shutdowns, capital shortages, perception of significant risk by banks, etc.

Also Read: What is Priority Sector Lending? Meaning, Objectives and Importance

Benefits of Co-lending Model

The idea of a co-lending arrangement has been around for a while, but since the Reserve Bank of India (RBI) established guidelines for the co-origination of loans, more banks and NBFCs have joined to provide funding to the priority sector. Although a co-lending system has several advantages, the most significant ones are listed here.

Better Technology

Financial institutions have gone digital to enhance the quality of operations and guarantee that funds reach those who need them at the appropriate moment. By utilizing reliable technology, practically all processes—from application through disbursal and service delivery—have seen faster turnaround times.

Lower Prices

The co-lending model is typically formed to meet the demands of the priority sector and spread credit throughout the economy. These consumers can receive a choice of items at cheaper interest rates.

The cost of attracting consumers and meeting their needs is also significantly reduced thanks to technology-driven algorithms introduced by digital lenders. Additionally, the lower cost of capital that banks bring in decreases the entire cost even more, which allows borrowers to profit.

Simple Access to Money

Lending processes are made easier for those who need money the most by using a digital strategy. Loans are now accessible through user-friendly, convenient, and customer-focused personal loan apps, which are only a few clicks away.

One only needs a smartphone and five minutes of free time. Therefore, when a digital borrower and bank work together under a co-lending model, customers get the best of both worlds because both digital channels and physical facilities are available. A co-lending contract outlines the obligations and duties of both parties in detail. The NBFC is typically in charge of sourcing, customer satisfaction and management, product development, quick paperwork, and quick turnaround, while the banks are in charge of bringing in cheap money and building a reputation.

Processes without Paper

Borrowers can obtain funds from the convenience of their homes because the entire procedure is automated. Everything from application to disbursal is available at your fingertips. Initial verification procedures required human labour, but modern lenders have embraced eKYC and Video KYC to streamline the procedure. It significantly cuts down on time and labour.

LoanTap and Bank of Maharashtra (BOM) have partnered to provide MSMEs with strategic co-lending. This methodology guarantees borrower convenience. The program seeks to offer clients who want to apply for a loan to finance their businesses with an MSME loan a simple and hassle-free process.

Enhanced Range

FinTechs employ digital channels to increase their reach to prospective consumers in contrast to traditional lending methods. It makes it easier to meet the needs of borrowers from various geographical areas. A co-lending approach provides the necessary funding to the economically disadvantaged strata.

Also Read: Principles of lending that every bank follows before allowing loans

How can Co-lending benefit globally?

The co-lending sector has grown significantly in prominence. Additionally, the pandemic's prolonged nature contributed to a global recession and historically high inflation rates. Here are some ways co-lending can benefit you. 

Increased Funding Access

By giving people and small businesses with no credit history before easy access to finance, NBFCs serve as a link- between the financially excluded and established banks. NBFCs provide the remaining 20% of the approved loan amount, with traditional banks providing the remaining 80%.

Greater Reach and Quicker Turnaround

Through NBFCs, co-lending enables financial institutions to access international markets and previously unbanked sectors and churn through more loan applications and disbursements, improving profitability through automation and instruments like substitute credit scoring that significantly cut underwriting costs and time.

Shared Risk and Return

Collaboration would entail sharing different risks and returns between the institutions and NBFC, improving lending techniques, and developing technologies. This will also aid in a more efficient and financially sound flow of money in the system.

Also Read: What is Peer-to-Peer Lending? Meaning, Features, and Benefits.

Reduced loan costs

Banks and NBFCs have been able to pass on the cost-benefit in the guise of lower interest rates because of their capacity to streamline the loan origination process. It implies that they can expand their market share, process and issue more loans, and increase the amount of credit flowing into the economy.

Conclusion

Given the involvement of two or more highly distinct business entities, each with its own processes, regulations, technology, and risk management strategy, co-lending may provide difficulties. It could take a long time for screening, disbursement, and receivables processes to fully integrate and still leave gaps. Lenders must work together more closely to accomplish the program's objectives and give customers a positive experience, particularly by seamlessly integrating their information systems. To tackle the operational difficulties brought on by co-lending, financial firms require a specialized and cutting-edge technology platform.

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FAQs

Q: What is Credit Expansion?

Ans:

During her recent visit to Mumbai in August, Finance Minister Nirmala Sitharaman met with the CEOs of PSU banks. According to her, credit expansion should be prioritized to support MSMEs and underserved market segments. Sitharaman stressed the importance of making the co-lending model work to increase accessible credit in her interactions with state-run banks.

Q: What should we do next?

Ans:

Experts agree that using the co-lending model is one of the best solutions to close the enormous credit gap. Still, technical integration issues and practical implementation issues need to be resolved.

The largest lender in the nation, SBI, recently declared that it is actively investigating co-lending possibilities with numerous NBFCs and NBFC-MFIs for financing agricultural mechanization, warehouse receipt funding, farmer-producer organizations (FPOs), etc.to increase credit flow and double the income of farmers and other borrowers.

Q: What opportunities are there?

Ans:

According to a senior executive at a mid-sized NBFC, the co-lending method will ensure that credit is delivered to the underserved and neglected if it takes off and is implemented correctly.In addition, the credit gap is with groups like small and medium-sized firms, those with low and moderate incomes, rural areas, etc.

Digital financing start-ups and mid-sized NBFCs can seize the opportunity and combine their distribution power with bank resources. Since NBFCs have a presence in tier-3 and tier-4 cities, banks that are rich in cash can serve a sizable customer base. It needs to be thoroughly checked on the implementation side.

Q: Why did co-lending take so long to get going?

Ans:

The Ministry of Finance has pushed PSU banks to use co-lending schemes several times. In the beginning, a few PSU banks established partnerships with sizable non-banks. For example, in September 2019, SBI partnered with ECL Finance, a division of Edelweiss Financial Services. However, some of these alliances didn't work out as planned. Bankers claim that while both banks and NBFCs are receptive to these types of tie-ups, the difficulty lies in their practical implementation. The key challenges included IT system implementation because banks and NBFCs used various operating systems and had unique underwriting procedures. All of these issues needed to be resolved for the marriage to take place.

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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.