Slide 1 - Intro

Before coming to the topic I must give a background

that According to a report by the Association of Chartered Certified Accountants (ACCA), the
Indian MSME segment faces a credit deficit of nearly $240 Bn.
(Source: https://accaindia.co.in/contenthub/Articles/images/ACCA_june.pdf)
Another emerging challenge to Indian lenders was highlighted by the Chairman of SBI, Mr.
Dinesh Khara, when he called on the banking sector to increase their green lending activities
to invest in sectors like renewable energy and sustainable infrastructure, while
simultaneously helping other sectors like agriculture, to mitigate the effects of climate
change.
To address the challenge of the rising credit gap within the underserved economy, RBI has
introduced this new model of partnership between banks and NBFCs.
In this article, we will decode the Co-Lending Model (CLM) and why it can become a key to
winning more market share for Indian lenders.

Slide 2 – What is co lending

Read the slide

Slide 3
Securitization –
Securitization is the transformation of financial assets into securities. Securitization is used
by financial entities to raise funding other than what is available via the traditional methods
of on-balance-sheet funding.
Many banks and private organizations have incomes or receivables that are due to them in
lieu of loans or services that they have offered in the past. Securitisation involves the
conversion of these incomes or receivables into debt instruments which are then sold to
investors. For this purpose, the parent organization sets up a Special Purpose Vehicle (SPV)
which issues these debt instruments.

By making these debt instruments available in the markets, the organization manages to
make their assets liquid and can then use the funds for some other productive business.
When an investor buys these debt instruments, the investor is given a PTC. However, this
does not mean that the investor owns the assets. Rather, when the original lender recovers
money from the original borrower (as interest or otherwise), it is then passed on to the SPV,
which then disburses it to the investor in the form of fixed income.

Slide 4
Banks and NBFCs were forming pacts to pursue new markets well before the introduction of
CLM. Previously, RBI had released a notification on 21st Sept 2018 titled ‘Co-origination of
loans by Banks and NBFCs for lending to priority sector‘ highlighting rules and regulations
for the parties involved in co-lending.
On 5th Nov 2020, RBI released another notification titled ‘Co-Lending by Banks and NBFCs
to Priority Sector‘ that served as a revision to the 2018 directions. 
Under this new version, all NBFCs (including HFCs) can enter co-lending pacts with partner
banks. RBI mandated that some bank categories under Scheduled Commercial Banks (SCBs)
cannot enter co-lending pacts with NBFCs. These banks include:
 Regional Rural Banks (RRBs)
 Small Finance Banks (SFBs)
 Urban Co-operative Banks (UCBs)
 Local Areas Banks (LABs) 
Slide 5
Benefits
Benefits for Banks and NBFCs
 Better Risk Management
NBFCs are in a position to manage and spot risk much better compared to large banks.
NBFCs and HFCs are more adept at assessing the creditworthiness of niche customer
segments, which are usually not the core target group of banks. With a more structured
approach, local focus and specialised skill set, they can evaluate credit applications better
and reduce the risk exposure for themselves and banks.
A modern Loan Management System can help tackle challenges like proportionate
sharing of risks and rewards, especially when an NBFC has multiple co-lending partners.
 Increased Reach of the Lending Ecosystem
Co-origination is based on the symbiotic association between NBFCs and banks. Public
Sector Banks (PSBs) in India have access to the most affordable source of funds in the
economy, and banks release 80% of the credit, which reduces the overall cost of funds.
NBFCs can benefit from this and offer loans to their customers at lower rates vis-a-vis their
competitors.
PSBs stand to gain from a partnership with NBFCs and fintechs as it enhances their last-mile
reach. Instead of a one NBFC one bank contract, co-lending can be imagined as an open
digital marketplace in the future. The co-lending framework will enable smooth and faster
credit flow to SMEs, with NBFCs acting as the last mile link.
 Efficiency In Operations

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With the use of automation and decision-making tools, co-lending allows lenders to have
higher margins by processing more applications and disbursing more loans in a shorter
span. The deployment of Artificial intelligence can help FIs analyse customer patterns and
predict default probability, helping them make faster and more data-backed decisions.
 Prevents Systemic Liability
Banks and NBFCs can manage capital efficiently and decrease their liability through co-
lending. They can scale their operations by finding lending partners with a good product-
market fit. To ensure no negative impact on the profit and loss statement, the on-balance
sheet spread that is lesser than or at most equivalent to the off-balance sheet spread can
prevent any negative impact on the profit and loss statement.
As co-lending is a collaboration between banks and NBFCs, both partners focus on increased
compliance and maintain it, thus preventing system liability.
Slide 9 – Outsourcing or DA
Whether the bank will provide an irrevocable commitment to take over a loan originated by
NBFC?
This looks like NBFC is carrying out the outsourcing function on behalf of the bank or it can
be said that bank has outsourced its function to NBFC.
The conclusion one gets from the above is as follows:
The essence of co-lending arrangement is that the participating bank relies upon the lead
role played by the originating bank. The originating bank is the one playing the fronting role,
with customer interface. The credit screens, of course, are pre-agreed and it will naturally be
incumbent upon the originating bank to abide by those. Hence, on a case by case basis or so-
called “cherry picking” basis, the participating bank is not selecting or dis-selecting loans. If
that is what is being done, the transaction amounts to a DA. Subject to the above, the
participating bank is expected to have its credit appraisal process still on.
Where it finds deviations from the same, the participating bank may still decline to take its
share. It is important to note that if DA comes into play, the requirements such as MHP,
MRR, true sale conditions will also have to be complied with.
However, co-lending transactions do not have any MHP requirements, unlike in case of
either DA or securitiastion. Of course co-lending transactions do have a risk retention
stipulation, as the CLM require a 20% minimum share with the originating NBFC. Hence,
the intent of the RBI is that co lending mechanism must not turn out to be a regulatory
arbitrage to carry out what is virtually a DA, through the CLM.

Read more at:

https://vinodkothari.com/?p=31768
So the question is – is this a co-lending transaction or outsourcing transaction.
This definitely is not a pure outsourcing transaction as NBFC also has exposure over the
loans. It is also not a pure co lending arrangement. We can say it is mix of two.
the CLM require a 20% minimum share with the originating NBFC. Hence, the intent of the
RBI is that co lending mechanism must not turn out to be a regulatory arbitrage to carry out
what is virtually a DA, through the CLM.
Slide 11- How can Digital improve the efficacy of CLM?
Over the last two years, India’s digital infrastructure has seen many innovations such as UPI,
Digi-locker, e-KYC, e-Sign, OCEN, Account Aggregators, and more that have vastly improved
the odds of success for CLM.
Now, the overall efficacy of CLM depends on the achievement of KPIs such as increasing the
accuracy of credit profiling, lowering the cost of borrowing, faster TATs, minimal credit risk,
higher operational flexibility, convenient repayment schedule, and more. A robust digital
stack can help co-lenders create a truly paperless process that will significantly bring down
the overall application processing time.  
For example, LeadSquared hosts many capabilities to support co-lending needs such as:
 One time API integration to simplify the flow of data between multiple lending
partners
 Rich data analytics and reporting to give you a 360-degree view into the
customer lifecycle journey
 A Workflow Builder to build highly flexible and agile borrower journeys in just a
few clicks
 Straight Through Processing (STP) for an end-to-end automated and completely
paperless journey
 Partner Onboarding and Management for a seamless co-lending experience
 A robust Debt Recovery platform to minimize loan delinquencies and maximize
collections
 Pre-screening functionality with checks such as Aadhar, PAN, CIBIL, Experian,
and more
For example, Profectus Capital, a leading Indian NBFC was able to increase its funnel quality
by over 70% using pre-screening capabilities offered by LeadSquared. Also, they were able to
achieve 60% higher process efficiency and optimize their spending on DSAs by nearly 55%.
Click here to read the full story
A robust tech stack will ensure that banks and NBFCs can make the most of their co-lending
partnership and maximize the financial inclusion of the Indian borrowers.
Before we wrap up, let us look at some of the co-lending pacts signed in 2021