The Evolution and Impact of Co-lending in India in Recent Years

NBFCs + Banks

In recent years, co-lending has emerged as a transformative model in the financial sector, particularly in India. This innovative approach, which involves collaboration between banks and non-banking financial companies (NBFCs), has aimed to bridge the ever-growing credit gap, enhance financial inclusion, and optimize fund utilization. Introduced by the Reserve Bank of India (RBI) in 2018 and redefined in November 2020, the co-lending model has swiftly gained traction. It brings the best of capital to the best of access/speed/tech. Let's delve into the evolution, impact, and future prospects of co-lending, enriched with insights from industry leaders.

The Genesis and Evolution of Co-lending

The RBI's introduction of the co-lending model in 2018 marked a significant milestone in the Indian financial landscape. The model was designed to synergize the strengths of banks and NBFCs, thereby enhancing priority sector lending and financial inclusion. The initial version, known as Co-lending Model 1 (CLM1), required customers to be onboarded with two lending entities simultaneously, a process that was later streamlined with the introduction of Co-lending Model 2 (CLM2) in 2020. CLM2 allowed customers to be onboarded just once on the front-end NBFCs stack, with up to 80% of the lending capital contributed by a banking partner.

Industry Leaders on Co-lending

At the NBFC Connect ‘24 held on May 11, 2024, several industry leaders shared their insights on the co-lending model. Vipul Sekhsaria, Co-founder & COO of Kaleidofin, highlighted the challenges and opportunities of co-lending. "We see how information asymmetry leads to a lot of gaps between two entities. Scalability and underwriting become challenging. Two entities coming together look if the partnership can get them better risk-adjusted returns, more customers, can the customer benefit from this partnership with better interest rates, more access, a frictionless process," he stated.

Ashish Mehrotra, MD & CEO of Northern Arc Capital, emphasized the importance of risk management in co-lending. "We look at risk on a first principle basis, adding value through the chain. For example, Nu Score as a tool helps to optimize and answer the most important questions: whom, how, what price to lend. Underwriting, validation, disbursal of the obligor across various asset classes," he explained.

Mehernosh Tata, CEO of Edelweiss Retail Finance, noted the early successes and future potential of co-lending. "We are in the early days but it has helped channel the needed money to MSMEs because the purpose was to serve the underserved. NBFC is the conduit by its way of underwriting and disbursal. Much needed to serve the growth capital and aspirations of entrepreneurs in India," he added.

Rakesh Kaul, CEO of Clix Capital, provided a broader perspective on the impact of co-lending. "Despite all the efforts in the last several decades, the credit gap is huge. The gap is growing at the CAGR of 12-13%. Through regulations like co-lending, it could be mainstreamed. It has crossed 1 lac crores, CAGR of 35-36%, showing that it has gained critical mass," he elaborated.

The Edge of Co-lending Partnerships

One of the key strengths of the co-lending model is the unique value that each partner brings to the table. Ashish Mehrotra highlighted the importance of collaboration, stating, "Everybody needs to work together. Partner brings the reach into place, because the partner has a limitation of what it can take on its balance sheet, we step in. The biggest challenge is reach or last-mile connectivity to the customer"

Mehernosh Tata added, "It’s not like 'one size fits all', we keep looking at the strengths that the partner brings in, for example, if the distribution strength is good. We look for strategic and long term, we are into MSME Lending, someone coming and talking about vehicles and gold, we might not be into it even though the opportunity is big. There are digital partners who at points of sale can capture the customers"

Challenges and Opportunities Ahead

While the co-lending model has shown significant promise, it is not without its challenges. Vipul Sekhsaria acknowledged the progress made with CLM2 but noted that CLM1 still awaits resolution of key components. "Our successes are notable in certain asset classes, particularly secured housing. However, there's ample room for expansion, especially in unsecured small business loans and microfinance. Rather than viewing it as a challenge, we see it as a promising opportunity," he said.

Rakesh Kaul pointed out the operational challenges faced by Public Sector Banks (PSBs) in managing the influx of data. "For Public Sector Banks (PSBs), some experienced exponential growth, but the test lies in effectively managing the influx of data. As we anticipate serving a larger population, standardization will be crucial. The demand for compliance is immense, making operations exceptionally challenging," he added

The Path Forward

The future of co-lending looks promising, with opportunities to amplify its impact further. According to Alok Mittal, Co-founder and CEO of Indifi, "As compelling as this innovation is, there are opportunities to amplify the impact further so that millions of entrepreneurs in India can be benefitted and the policy makers’ goals around credit inclusion are met." He also suggested that opening up NBFC-to-NBFC co-lending under CLM2 for priority sector lending could create more efficient and sizable capital flows to MSMEs.

In conclusion, the co-lending model has significantly contributed to financial inclusion and optimal fund utilization in India. While challenges remain, the collaborative efforts of banks, NBFCs, and fintech companies promise a brighter future for the sector. As Vipul Sekhsaria aptly put it, "Rather than viewing it as a challenge, we see it as a promising opportunity".