Bank-NBFC co-lending: how it works, and the concerns it raises

News: Several banks have entered into co-lending ‘master agreements’ with NBFCs, and more are in the pipeline

Recently, the RBI permitted the banks to co-lend with all registered NBFCs (including HFCs) to increase lending to the priority sector based on a prior agreement.

This has led to unusual tie-ups between banks and NBFCs. For instance, SBI signed a deal with Adani Capital, a small NBFC, for co-lending to farmers to help them buy tractors and farm implements.

What is the Co-Lending Model?

Operational flexibility: Co-Lending Model allows for a joint contribution of credit at the facility level by both the lenders, as also sharing of risks and rewards.

AIM: to improve the flow of credit to the unserved and underserved sector of the economy

Rationale behind this model: The lower cost of funds from banks and greater reach of the NBFCs will make available funds to the beneficiary at an affordable cost.

Significance for banks:  It will help banks to expand customer base and enables them to provide last mile banking services.

What are the issues/challenges in RBI’s co lending model?

Disproportionate risks on Banks: Under the CLM, NBFCs are required to retain at least a 20% share of individual loans on their books. This means 80% of the risk will be with the banks and in case of a default banks will take the big hit.

Disparity in roles and responsibilities: For instance, the RBI guidelines provide for the NBFCs to be the single point of interface for customers, and to enter into loan agreements with borrowers. In effect, while the banks fund the major chunk of the loan, the NBFC decides the borrower.

Corporates 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.

Recent failure of NBFC’s increases the risk: For instance, the recent collapse of four big finance firms (IL&FS, DHFL, SREI and Reliance Capital). Collectively, these firms owe around Rs 1 lakh crore to investors.

RBI’s reasoning that NBFCs have wider reach is flawed: 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.

Source: This post is based on the article “Bank-NBFC co-lending: how it works, and the concerns it raises” published in Indian Express on 14^th Dec 2021.