What is co-lending and how does it work? – Forbes Advisor INDIA
Lending refers to the transfer of money from one party to another for a period of time in exchange for a future promise that the borrower will return the money to the lender along with interest (generally determined at the time the loan is originated). Arrangement).
“Co” is short for collaboration, or in other words, the coming together of two or more parties for a specific purpose or project. Generally it is used in its shortened form “Co” and as a prefix to the actual project title to show the partnership between the parties.
Therefore, from the above two definitions, we can conclude that co-lending refers to the coming together of two or more lenders to jointly lend money to their target audience.
Co-lending has been around in India for some time (2012-2014) but has recently started to announce its potential in the Indian scenario with the rise of fintechs and new-age non-banking financial firms (NBFCs). . Lending has become the business of the elite, and every big company out there wants a piece of the pie. However, the granting of loans requires two essential conditions:
- Middle – which is not a cheap endeavor for smaller and newer players as they have to raise the funds themselves from a larger company, which in turn comes with their own interest liability.
- Ready consumers – One of the most important steps in lending is to find creditworthy customers as the risk of your loan becoming bad debt needs to be minimized.
Newer players (fintech and NBFCs) tend to have a broader target audience for lending due to their customer-centric approach and increasing prospect acquisition via social media and digital acquisition, but do not have convenient access to large funds to lend to their customers .
Established players (banks), on the other hand, have a large amount of funds ready to be used for the right group of customers, but their customer acquisition strategy does not stick to digital penetration and they mostly stick to their offline acquisition strategies.
Co-lending helps these two types of entities come together under one lender umbrella and leverage their respective synergies to provide a holistic experience for the benefit of all parties to the arrangement.
Terms of a Co-Lending Agreement
A co-lending arrangement usually involves two companies coming together – an NBFC and a bank – to leverage their respective capabilities. According to the guidelines for joint lending prescribed by the Reserve Bank of India (RBI), the following are typical terms of the agreement between the parties:
- 80-20 split: Loans are allocated at an 80:20 principal ratio between the bank and NBFC. This allows the bulk of the capital to come from banks, which have access to a cheaper source (demand deposits), and NBFCs can also be the consumer-facing entity that takes care of sourcing and the appropriate experience for customers.
- Joint underwriting: Since both entities have a role in the game, underwriting is also done jointly, allowing for double checks.
- Risk-return split: The 80/20 capital split mentioned above also results from the amount of risk and return shared between the two companies.
- Charged final interest rate: Banks typically have lower costs of capital and NBFCs typically have higher costs. Therefore, the final rate of interest passed on to customers is generally a combination of the weighted average cost of capital plus their respective commissions, which are usually between the rates individually charged by the bank and the NBFC.
- Defined roles: The roles and responsibilities of both entities are clearly defined in a co-loan agreement. In general, the NBFC is responsible for sourcing, customer experience and management, product innovation, fast documentation and quick turnaround time, while the banks are responsible for bringing in cheap funds and establishing credibility.
Advantages of co-lending
- Greater range: NBFCs typically have wider reach into the country’s most remote areas, underserved audiences, and digital penetration. Therefore, banks can benefit from a larger pool of companies and customers to lend to.
- Better customer experience: NBFCs and Fintechs have customer centricity as their main goal and hence the entire customer management process of the banks is handled by the modern partner in the agreement with its smooth and convenient processes, which helps in conversions and repeat lending opportunities in the future.
- Skin in game: Since the NBFCs must also contribute at least 20% of the capital, this reassures many banks with regard to the quality of the referred customers and significantly reduces the underwriting effort for the bank.
- Risk management: By sharing the risk between the two partners, banks can benefit from an additional sense of security and minimized losses should things go wrong.
- Less interest: Banks are in the enviable position of having access to the economy’s cheapest sources of finance. Therefore, NBFCs can use a co-lending arrangement to lend at lower interest rates compared to their peers.
- Credibility: New-age companies looking to get into lending can build credibility for their brand in the eyes of customers through co-lending partnerships with major banks.
- Risk management: Because of the risk-sharing between the two partners and the majority of the banks’ capital, NBFCs can reduce the losses on their loans in the event of bad debts.
- Better consumer experience: New age partners like fintechs ensure the customer has the smoothest experience throughout the process to keep them engaged and sell financial products in the future.
- Lower interest rates: Consumers don’t have to pay extremely high interest rates just to go through a convenient credit process, as they get significantly lower interest rates through the involvement of banks.
- Underserved customers: Traditionally credit-disadvantaged rural communities and those with less credit histories are a good fit for co-lenders as they finally have access to bank lending products, albeit indirectly.
- knowledge dissemination: NBFCs and Fintechs provide the personal touch and go the extra mile to not only source the end customer but also educate them on the terms of the loan agreement, thereby also contributing to the financial literacy of underserved customers.
How to choose the right co-lending partner?
As with any other business partnership, co-lending arrangements should be entered into with extreme caution as, in addition to the obvious financial risk involved, your overall brand image could be compromised or damaged by the actions of the other party.
Some things for potential partners to consider are:
- focus area
Some lenders are industry agnostic, but many of them also have a specific focus on a particular economic sector or target audience such as professionals, etc. Therefore, similarity of focus becomes important when entering into an agreement.
- risk appetite
The potential partner’s risk tolerance and capacity is extremely important to match with yours, as future disputes over reorganizations and bad debts could get ugly if things don’t go as planned.
- ticket size
The average loan amount with the wide range must be agreed when concluding a joint loan agreement, so that there are no inequalities in the future.
- process nuances
Some lenders have a specific approach to documentation, customer retention, customer service, etc. Therefore, it is extremely important for both parties to get complete clarity about it before starting the joint lending arrangement.
Application and opportunities for co-lending
- Loans to underserved and priority sectors
Co-lending has enabled increased liquidity and credit penetration in underserved sectors of the economy such as rural areas, MSMEs and others due to the wide reach of NBFCs. This is contributing to an increase in the number of first-time borrowers in the country, thus playing a large part in closing the existing credit gap of around a few trillion rupees.
Also from a regulatory point of view, the RBI mandated all banks to lend part of their Net Bank Credit (NBC) to some identified priority sectors of the economy. Co-lending arrangements allow banks to easily meet the procurement requirements for such loans, which in turn benefits the economy at large.
- Coming together of banks and NBFCs
If we look at the Indian economy as a whole, both banks and NBFCs play an important role in greasing the wheels of the system by providing a constant flow of cash to the right businesses and customers, which in turn increase demand and production of goods and services. Co-lending allows two key pillars of the economy to come together and expand their respective capabilities, making the whole process smoother and also expanding the target market itself.
This unique arrangement may offer tremendous opportunities in the times to come, with the expected disbursement of around INR 300 billion by FY23 itself.
- technological interventions
Co-lending offers a unique opportunity to transform the age-old lending industry into a convenient and gamified experience for the end customer through fintech-led technological interventions. Banks are struggling to modernize their underwriting, documentation and customer service processes, resulting in a loss of 21St Century customers who are used to financial products at the push of a button.
With digital finance literacy and credit penetration also two key areas of focus for the government, we can expect a range of innovations around collaborative lending arrangements in India.
Co-lending has gone far from being just a buzzword to the point of being recognized by the RBI and the publication of appropriate guidelines for its implementation in the country. A number of start-ups and banks have started collaborating on lending in niche segments of the economy, and we will only see an increase in technology-enabled product innovation and loan books in the coming times.
However, with any type of lending, joint lending also comes with numerous risks, and with NPAs constantly in the limelight in the economy, joint lending arrangements would also be tested for their robustness and fundamentals for the future.