One of India's fastest-growing loan categories right now is relatively unique to this market - Co-lending. Last week rating agency CRISIL flagged that Co-Lending has witnessed a phenomenal rise and is set to be a USD 12 Billion Loan book by this June.
What is behind this growth? India’s co-lending history might give you some context…
Co-lending in India is fascinating. It emerged around 2014, a decade after the country's financial sector underwent significant liberalization. This period saw a surge in capital market activity, but credit flow to crucial sectors like agriculture and small businesses remained sluggish. This was partly due to a long-standing Priority Sector Lending (PSL) regulation. Here's the thing about PSL: it mandates banks to allocate a portion of their loans to these very sectors, which are considered essential for the economy's development but often deemed riskier by banks. Meeting these PSL targets proved inconsistent for banks.
Enter Non-Banking Financial Companies (NBFCs). These nimble players, often with deep regional roots and expertise in specific borrower segments, were well-positioned to serve the underserved. However, their ability to expand was limited by access to affordable capital. This is where co-lending emerged as a win-win solution. Banks could leverage NBFCs' reach and expertise to fulfil their PSL obligations, while NBFCs gained access to cheaper funds from banks to fuel their growth.
The story doesn't end there. The rise of fintech companies (mostly digital lending focused) soon after, further amplified the co-lending opportunity. Fintechs brought automation, data analytics, and a digital-first approach to the table, streamlining loan processes and making credit assessment more efficient. This three-way collaboration – banks, NBFCs, and fintechs – became the recipe for co-lending's success in India.
Essentially, co-lending enhances financial stability by enabling risk sharing between two institutions and (often) subjecting borrowers to dual scrutiny and integrating stringent compliance and risk management practices.
The mandatory risk-sharing, means both parties retain stakes in the loans (usually the bank funds 80% and the NBFC funds the other 20%), aligning assets and liabilities to avoid management pitfalls
While the co-lending model is unique to India, it varies in its implementation globally. Take The "Fannie Mae's Small Loan Program" in the US - it involves a partnership between Fannie Mae and local lenders to offer financing for smaller multifamily properties. This co-lending arrangement leverages government backing and local market insights, enabling loans that might be considered too risky or small for individual lenders to manage alone.
In the European Union, the European Investment Bank (EIB) collaborates with local banks in several countries to fund projects that align with EU goals, including innovation, environmental sustainability, and infrastructure improvements. The EIB contributes to these loans on favourable terms, thereby reducing the financial risk and burden for local banks.
The core principles of this collaborative lending model are the same across the globe - collaboration between different financial entities consistently aims to enhance economic opportunities and financial inclusivity.
And it works..
Take NBFC X for instance (one of the largest Non-Bank Financial Companies in India). By strategically partnering with digital platforms, fintechs, and banks, NBFC X was able to streamline loan origination, particularly for personal and business loans. This not only helped them expand their customer base but also achieve higher returns on equity compared to traditional lending models.
Despite incurring operating costs, this model yields a higher RoE compared to traditional lending approaches due to reduced credit costs and capital requirements.
Co-lending is a great lever for banks, Non-banks, fintechs and borrowers. However, it's technology that can truly take co-lending to the next level.
This is especially crucial considering the hurdles posed by traditional banking systems and the regulatory landscape within co-lending in India.
Bridging the Gaps: How Technology Smoothens the Co-Lending Journey
Co-lending isn't without its challenges. Here's where things can get bumpy:
- Clash of Cultures: Banks and NBFCs operate in different worlds. Banks have robust (sometimes slow) systems and stringent credit checks, while NBFCs are agile and cater to non-traditional borrowers.
- The Co-Lending Maze: Before any money flows, banks and NBFCs must navigate a complex co-lending master agreement (CLMA). This agreement outlines everything from interest rates (a calculation that considers each lender's risk tolerance and loan share) to loan monitoring and handling defaults. Negotiating these terms can be time-consuming and intricate.
- Interest Rate Tango: Determining the final interest rate for borrowers involves a delicate dance. Banks and NBFCs have varying risk appetites, leading to negotiations to arrive at a "blended rate" that works for both. Whether it's a fixed or floating rate, complex calculations are needed to reach a final figure.
- Disparate Data, Disgruntled Borrowers: NBFCs and banks often rely on different credit bureaus or data sources. A borrower deemed creditworthy by the NBFC might be flagged as risky by the bank, leading to rejections and frustration.
- Escrow Hurdles: The escrow account, which centralizes co-lending finances, can be a source of friction. While traditional banks offer robust escrow infrastructure, there's room for improvement in terms of user-friendliness.
- Reconciliation Tango: Disparate calculation methods and managing multiple repayment schedules (full loan, bank's 80% share, NBFC's 20% share) create complexities. Reconciling disbursements, collections, and repayments across various scenarios becomes a challenge.
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The scalability of co-lending heavily relies on technological integration. Modern co-lending platforms, designed with a 'tech-first' approach, utilize API-based underwriting, digital data exchange, and automated financial flows, smart contracts to ensure efficiency and adaptability. This technology is not just an operational tool but a strategic asset that enhances the model's ability to support diverse lending activities such as small business loans or instant consumer credit.
By handling everything from loan sourcing to escrow management, these platforms are not just add-ons; they're game-changers. Thanks to India's digital leaps with UPI, e-KYC, and more, the potential for Co-Lending’s success is higher than ever. The real magic happens when co-lending works seamlessly, slashing borrower costs, speeding up processes, and offering flexibility all around.
As co-lending matures, its future success will increasingly depend on collaborative efforts between traditional financial institutions, NBFCs, and fintech innovators. The model exemplifies a significant shift towards more inclusive and efficient financial services, aligning with global trends towards digital transformation in banking.
What do you think?
I'm eager to hear your thoughts on co-lending and how fintech can continue to thrive in the future of finance!
