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Bank-NBFC Co-lending

  • 14 Dec 2021
  • 5 min read

Why in News

Recently, several banks have entered into co-lending 'master agreements' with registered Non-Banking Financial Companies (NBFCs), and more are in the pipeline. In 2020, the Reserve Bank of India (RBI) allowed the co-lending model based on a prior agreement.

  • However, there are some criticisms associated with the co-lending.

Key Points

  • About the Co-Lending Model:
    • Background: In September 2018, the RBI had announced co-origination of loans” by banks and NBFCs for lending to the priority sector.
      • The arrangement entailed joint contribution of credit and sharing of risks and rewards. Co-lending or co-origination is a set-up where banks and non-banks enter into an arrangement for the joint contribution of credit for priority sector lending.
      • These guidelines were later amended in 2020 and rechristened as co-lending models (CLM) by including Housing Finance Companies and some changes in the framework.
      • Under priority sector norms, banks are mandated to lend a particular portion of their funds to specified sectors, like weaker sections of the society, agriculture, MSME and social infrastructure.
    • Objective: The primary focus of the ‘Co-Lending Model’ (CLM) is to “improve the flow of credit to the unserved and underserved sector of the economy.
      • It also envisages making available funds to the ultimate beneficiary at an affordable cost.
    • Underlying Idea: CLM seeks to better leverage the respective comparative advantages of the banks and NBFCs in a collaborative effort.
      • The lower cost of funds from banks
      • Greater reach of the NBFCs.
      • For example, CLM will enhance last-mile finance and drive financial inclusion to MSMEs.
    • Example of CLM: SBI, the country’s largest lender, signed a deal with Adani Capital, a small NBFC of a big corporate house, for co-lending to farmers to help them buy tractors and farm implements.
  • Risk in Co-lending:
    • Majority of Responsibility Lies with the 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 — who will take the big hit in case of a default.
      • 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, the NBFCs are mostly floated by corporate houses.
      • This is risky, especially when four big private finance firms — IL&FS, DHFL, SREI and Reliance Capita have collapsed in the last three years despite tight monitoring by the RBI.
    • Limited Reach of NBFCs: While the RBI has referred to “the greater reach of the NBFCs”, the small NBFCs with 100-branch networks will fall short in serving underserved and unserved segments.

Way Forward

  • There is a need to give greater powers to the bank's board in order to drive, review & oversight the decision-making process. And for that, the best talent must be recruited.
    • Also, there is the requirement of a much stronger risk handling mechanism.
  • The need is to now look at foreign markets, and set up appropriate business policies (in terms of the global location & the product these banks can target) that will help in increasing the efficiency and the competition of these banks with their global counterparts.
  • Continuous reforms should be undertaken regarding,
    • Product innovation,
    • Investments in technologies,
    • Better back-end processes,
    • Reduction in turnaround time.

Source: IE

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