Bank-NBFC Co-Lending: An Idea Yet To Find Its Feet

“There have been a lot of discussions and engagements between NBFCs and banks, but a significant number of arrangements are not in yet. They are all in various stages and while a few engagements have started, there has not been a considerable pick-up,” said Krishnan Sitaraman, senior director at Crisil Ratings.

Under the co-lending model, non-bank lenders can originate loans independently and later sell them down to their partner banks on a back-to-back basis, while retaining a minimum of 20% share of individual loans on their books. The loan is offered to the customers at a blended interest rate, often a weighted average of rates offered by both lenders.

The model slightly differs from direct assignment as it does not require NBFCs to season their loans for a certain period. It also has some features of co-origination as partner lenders are required to maintain each individual borrower’s account for their respective exposures, while all transactions (disbursements/ repayments) are routed through an escrow account maintained with the banks to avoid intermingling of funds.

“There was not much traction in the earlier (co-origination) arrangement as there were issues on the technology front, but co-lending is an extension of direct assignment with no minimum holding period. Presently, the model is working mainly for home loans, gold loans and vehicle loans,” Sitharaman said.

A number of co-lending arrangements have been announced but no official data is available on the extent of lending under such arrangements so far.

On Friday, PNB Housing Finance announced its partnership with Yes Bank for co-lending retail home loans. Under a similar arrangement, IIFL Home Finance extends home loans with Standard Chartered Bank, and Bank of Baroda facilitates loans with Edelweiss Financial Services. State Bank of India, too, has a two-year-long tie-up with Paisalo Digital for income generation loans. In February, Bank of Maharashtra entered a co-lending arrangement with Pune-based NBFC LoanTap Credit Products for financing micro, small and medium enterprises.

“The co-lending model has not achieved a significant size or scale yet, mainly because of the initial teething challenges over the execution of co-lending arrangements,” said Jinay Gala, senior analyst at India Ratings and Research. The issues faced are largely on the “legal and technology front and over the risk-sharing arrangement at the time of onboarding the customer” he said.

Too Complex?

NBFCs have not completely warmed up to the co-lending model yet, mainly as they seek more clarity on legal and technological linkages required for such lending.

Take Indostar Capital Finance for example. The NBFC specialises in used and new commercial vehicle financing and has a long-term arrangement with ICICI Bank, through which it has built close to 7% of its assets under management of independently originated CV finance loans, which are disbursed entirely by its partner bank. In return, Indostar earns a portion of interest income while acting as the front-end for all its customer needs.

“While co-lending has a lot of potential, we find our existing model favourable in which we act as an originator of loans for our partner bank, as this removes the need for investing in aligning the technology infrastructure or having any complex arrangements over disbursements. Ours is a much simpler model,” said Amol Joshi, chief financial officer at Indostar Capital.

Some banks share that view.

“It is easier to have NBFCs as loan originators ensuring customer service, while the disbursement could happen entirely through the bank. It also removes the fear for NBFCs that their borrowers may shift their loyalties to partner banks,” said CVR Rajendran, managing director and chief executive at CSB Bank that has arrangements with some NBFCs for sourcing gold loans.

The co-lending partnership model, according to Rajkiran Rai G, managing director and chief executive of Union Bank of India, has taken time due to issues over technology integration with partner NBFCs.

“We are still working on technology linkages, such as putting in processes for real-time sanctioning loans sourced by the partner NBFCs, along with putting in a mechanism to share collections on a daily basis. Further, the loan account statement for customers also needs to be consolidated,” he said. While these integrations are taking time, the bank may be able to announce few co-lending partnerships for MSME loans by April.

The co-lending solution also does not adequately solve the issue of funding constraints for smaller NBFCs. This, as banks prefer to form co-lending partnerships with the larger non-bank lenders. “It is the smaller NBFCs facing funding constraints that really need the co-lending solution, as the larger ones can originate and service their loans independently,” Joshi said.

Rai of Union Bank said the lender is talking to large to medium-sized NBFCs as it is easier to integrate its systems with them but will look at smaller ones in the future. Nirmal Jain, founder and chairman of IIFL Group, agreed that banks look for partnerships with NBFCs of a certain scale and size because of their evolved technology architecture and greater reach. Even there, the pick-up is slow so far.

“The co-lending model has just started for us and transactions have begun, but it is still not a significant portion of our book. However, we expect it to grow rapidly. We are in discussions with our banking partners on how to smoothen the processes to make it work seamlessly for both of us,” said Jain. “There are issues regarding technology infrastructure alignment and integration of workflows, but once that is done co-lending could form close to 50% of our book over the next three years,” he said.

A Model For The Future?

Even as co-lending faces teething challenges, once those are ironed out, the model could see a significant uptake among lenders, said Gala. “As we move forward there could be a decent ramp up, and even new NBFCs can crop up with business models formed around co-lending,” he said.

While traditional NBFCs are taking time to iron out the technology alignment issues with their partner banks, Paisalo Digital, a non-deposit taking NBFC and one of the early adopters of the co-origination model, has found co-lending most favourable for its business.

“No form of direct assignment will work for an NBFC like ours as the market we serve is largely under- or unbanked, and if we were to originate those loans independently and later sell them down to partner banks, it will create an unnecessary hassle of funding them at the time of origination. Instead, we prefer to co-originate and co-lend these loans with our banking partners,” said Santanu Agarwal, deputy chief executive officer at Paisalo Digital that has both co-lending and co-origination partnerships with the State Bank of India since 2019 for Rs 1 lakh or below loans.

The company, he said, took two months to align its technology infrastructure with SBI and is in the process of forming similar partnerships with other public-sector lenders.

“For processing large volumes of loans below Rs 1 lakh under the co-lending partnership, a large part of the credit workflow, from know-your-customer requirements to disbursements, needs to be automated. Once that process is digitized, the sky is the limit for co-lending,” he said.

Currently, Paisalo has close to 4% of its Rs. 2,300 crore total loan book under the co-lending model, and is looking to increase its assets under management to Rs. 8,000 crore under the model over the next three years.

“Considering many NBFCs have faced funding challenges post the IL&FS collapse and during the ongoing pandemic, co-lending could help them create an asset-light and funding-light growth model in which their assets under management will grow but they don’t need to borrow so much, resulting in a higher return on assets,” said Sitaraman.

Having a portion of co-lending on their books also prepares NBFCs for future funding challenges as they can then rely on their co-lending partnerships to keep the business going. “Non-bank lenders can continue to do 15-20% of their business under the model as it will help them broad base their funding profile and insulate them against any future black swan events,” he said.