A few months back, RBI set out the framework related to the co-origination of loans by NBFCs and banks in the priority sector. This model came into existence to neutralize the liquidity crisis at NBFCs to improve the credit flow of priority sectors. The model was widely recognized as a Co-lending model, aka CLM.
What is the Co-Lending Model?
Co-lending refers to a collective operation of two or more entities in the financial sector. In general, co-lending happens between banks and NBFCs or smaller banks and larger banks. Financial interfaces between different entities may take the form of co-lending, securitization, direct assignment, loan referencing, banking correspondents, etc.
While securitization & direct assignment have been in existence for some time, co-lending was allowed by Reserve Bank under its prevailing norms on ‘Co-origination of loans between banks and NBFC-SIs for granting a loan to the priority sector’.
Given the Developmental and Regulatory Policies’ statement, Reserve Bank decided to broaden the spectrum of co-lending, currently allowed only for NBFC-SIs, to all NBFCs. Accordingly, the Reserve Bank came with a new regulatory framework vide notification regarding Co-Lending Model emphasizing priority sector loans dated Nov 5, 2020. The Co-lending supersedes the prevailing norms on co-origination.
What are the Major Benefits of the Co-Lending Model?
- Enables a bank to give out the more substantial chunk of funds
- Allows traditional lenders to associate with Fintech firms
- Provide an excellent avenue for NBFCs to grow their assets under management.
- Omit funding-related challenges or capital constraints
- Facilitate healthy growth of priority sector loans
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What is the Potential Applicability of the Co-lending Model?
The form norms for priority sector lending encompassed co-lending transactions of NBFCs-SI and Banks. But, Co-Lending Model covers all Non-Banking Financial Companies, including HFCs, under its ambit.
Most Fintech organizations leverage Algo-based originations and proactively use the internet for originations, and these firms pass a considerable part of their lending to either banks or NBFCs.
Therefore, the broadened spectrum of the CLM will improve the penetration and ensure widespread reach, meet the goal of financial inclusion, & minimize the cost for the loans’ beneficiary. Smaller NBFCs excel on their distribution capabilities & operational efficiencies; thus, this is a prudent move.
Moreover, the Reserve Bank excluded overseas banks, including wholly-owned subsidiaries having less than 20 branches, from the CLM’s ambit. Also, small banks, Urban Cooperative Banks, Urban Cooperative Banks, & Local Area Banks have received the same treatment.
Pre-Condition on Co-Lending Model
An interesting question that arises here is whether such exclusion should be interpreted as a limitation on such entities or relaxation from the CLM’s applicability. It’s worth noting that the Co-Lending model is a precondition for Priority Sector lending treatment of the loans. The aim is not to bar on existence on CLM arrangement outside Co-lending model.
With that said, if the loan, granted by the principle co-lender in the form of a priority sector loan, the participating co-lender can treat the participant’s share of the loan as a Priority Sector Loan, subject to adherence to the CLM’s conditions. This means if the loan fails to meet the CLM’s conditions, the participating bank may not accord a PSL status, even if the loan in question is a PSL loan.
Further, this indicates that excluded banking entities may operate as co-lender. However, PSL Master Directions have a different implication: it explicitly excludes RRBs, UCBs, SFBs, and LABs under co-origination of loans by SCBs NBFCs to PS.
Interest Rates on Loan Originated under Co-lending Model
The former guidelines specifically emphasize Blended Interest Rate Calculations to estimate interest rate charged on the loans under co-lending guidelines. Nonetheless, as per the new model, the estimation of interest rate shall be done by assigning weights corresponding to risk exposure to the respective lender’s benchmark interest rate.
The prevailing norms require that the interest rate be an inclusive rate, mutually agreed upon by the parties. But, it should make sure that the interest rate imposed is not stringent as the same would violate the conditions cited under the fair practice code.
This change would impart flexibility to the lenders and also make sure that the cost incurred in disbursals to the remote sector is aptly compensated.
Role of NBFCs under the Co-lending Model
The preceding provisions specified that the share of the co-lending NBFC should not be less than 20%. The same has been maintained in the Co-lending model as well, requiring NBFCs to maintain at least of 20% share of individual loans in their books.
Under the CLM, co-lending NBFC shall act as a single point of interface for the clients. Moreover, the grievance redressal function should also be set up and carried out by these entities.
What are the Operational Aspects of Co-lending Model
Following are the operational aspects of the Co-lending model suggested by the Reserve Bank of India via notification:-
The CLM specifies the opening of an escrow account for the purpose of disbursals, collections, etc. The co-lending banks & NBFCs were obligated to maintain every borrower’s account for proper exposures assessment. The escrow mechanism helps in avoiding the commingling of funds. The bank and NBFC should sign a master agreement enclosing rights & duties regarding the escrow account.
Each of the lenders must post their respective exposures in their books. The asset classification, as well as provisioning, should also be done for the purpose of exposure. To serve this purpose, the account’s monitoring may either done by the co-lender or one of them, as per the conditions in the Master Agreement. Generally, the monitoring functions stay with the NBFC since it has done the dealing with the customers.
Creation of Security
The method for creating a charge on the security for the loan shall be mentioned in the Master Agreement itself.
Co-lending Model enables the banks to give more funds and allows and lenders to link with fintech firms that have greater digital reach and alternative credit scoring models.
It will also provide a conducive platform for NBFCs to thrive their assets under management. It will mitigate the funding crisis and capital constraints by ensuring by empowering NBFCs to provide sustainable credit to the priority sector.
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