Is Co-lending The Final Answer To The NBFC Crisis? Let’s find out!

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2019 was a wake-up call for the RBI, Government, and the economic experts to focus on the NBFC crisis on priority, if the lending industry is to be saved from a collapse.

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The IL&FS issue had long remained unsolved, and the drying up of funds from the PSU Banks in the rise of unearthing of scams led to a tight capital crunch for the NBFCs.

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Banks refusing to refinance loans has cropped up a massive dearth of liquidity. Many veteran bankers including Uday Kotak and Marzban Irani feel that it is only a matter of time before the turbulence in the financial sector affects the entire economy.

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While RBI has tried to elevate the situation by cutting Repo rate for the 5th time in a single year (2019) to the 9-year low, the government looks hopeful about co-lending as the potential and permanent solution. RBI had already laid out the framework for the co-origination model more than a year ago, but it was around April 2019 that SBI actively started talks with 4-5 NBFCs to roll out its co-lending model.

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What is co-lending/co-origination of loan?

• Co-lending, or co-origination of loan is an arrangement between a domestic commercial bank and an NBFC to jointly issue credit and manage loans at the facility level.
• Co-lending, or co-origination of loan lifts the burden and risk of an entire loan from the shoulders of a single entity.
• A bank and an NBFC jointly issue a loan with the exposure ratio being 80:20 of all the risks and rewards between them.
• Such co-originated loans can only be issued for “priority sector lending”.

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What does Priority sector include?

• Agriculture
• MSMEs
• Export Credit
• Education
• Housing
• Social infrastructure
• Renewable energy, and others.

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Why is co-origination/co-lending of loans important?

• According to the RBI Master Circular, domestic scheduled commercial banks need to have the total priority sector lending (PSL) at 40% of the new adjusted bank credit or credit equivalent amount of off-balance sheet exposure, whichever is higher.
• There are also sub-targets for each sector; especially for agriculture and MSMEs.
• However, currently the banks, which barely manage, and at times incredibly fail to correctly evaluate, assess, and underwrite the credit of the borrowers of the urban PSL category due to lack of resources, have little time and effort to spare for the remote geographies.
• Hence, banks are looking for new avenues to meet the targets without it being a burden on their existing resources, which fits in the co-lending model.
• It is an attempt by the RBI to ensure the flow of capital to the priority sectors while mitigating challenges by the financial institutions in doing so.

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How will co-lending actually work?

• Currently there are no RBI guidelines to regulate co-lending. However, it has soon promised to come up with them to systematically establish and run the co-lending model.
• The entire process of lending- right from co-origination of loans to the loan management/monitoring to the loan recovery and settlement will take place digitally through automation, without any human intervention, as suggested by the SBI in an official statement.

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How many entities in India are already a part of the co-lending model?

State Bank of India, Bank of Baroda, and the Union Bank of India have already announced their ventures with respective NBFCs. Other banks are expected to follow them.

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Is this really beneficial for the NBFCs?

• From all the discussions it looks like though the model was chalked out due to the rising challenges in the NBFC sector, it serves more as a medium for the big banks to reach to the grass-root level borrowers and MSMEs.
• However, to deny that NBFCs do not benefit in the entire process would be ignorance.
• It addresses the major problem NBFCs in India have been facing for a long time- lack of established systems of the banks to reduce the risk of defaults.
• With co-lending, NBFCs can exploit the expertise and diligent processes of the banks to issue loans, and also share the risk of default.
• It also encourages NBFCs to go fully digital with their operations to increase transparency in the ecosystem
• Lastly, co-lending/co-origination of loans boosts the growth, assets, and profitability of the NBFCs without much investment.

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The ultimate goal of the co-lending/co-origination lending model is to eventually bridge the gap in micro-lending between the banks and the remote areas which were otherwise inaccessible without the NBFCs. However, it yet remains to be seen how, what looks so promising on paper, turns out to be on execution.