Five years on, co-lending's performance on the field may need a closer look

In September 2022, CRISIL Ratings evaluated its first-ever transaction of receivables originated under co-lending and business correspondent arrangements — for a ticket size of Rs 32-crore — and assigned a ‘Provisional CRISIL A’ to the 'Series A1 pass-through certificates’ issued by Leo August 2022, backed by U GRO Capital. The shadow bank seeks to grow its co-lending book three times to Rs 2,000 crore by the end of FY23, and has signed 18 partnerships, including with State Bank of India and 

IDBI Bank.

Now, not a fortnight passes by without an announcement of a co-lending partnership between banks and non-banking financial companies (NBFCs). It’s an arrangement hammered out in late 2018 to boost credit flow to sectors that have struggled to get enough of it in an 80:20 partnership. The idea: Carve out the risks between banks and NBFCs with an emphasis on long-term structural reforms. And the emerging model was to go beyond the plain vanilla, nor not be restricted to the 

priority sector.

The model was flagged off on September 21, 2018, but the building blocks took time to come into view. The reason: The principals — banks and NBFCs — had to dance around issues after the blowouts in shadow banking, and iron out the finer aspects of the model. Just about every other state-run bank and select private banks have set up co-lending verticals. But five years on, there’s no systemic data on it — either from Mint Road or rating agencies or even industry bodies. And it’s tough to 

get a sense of how it is working on the ground.

A time for caution

Take Canara Bank, for example. It’s not been active in co-lending -- its book is just about Rs 230 crore as it worked to digitise the process and its maintenance. But it's take-off time with caution thrown in. “We are cognizant of the regulator’s concern on retail loan growth, especially in unsecured credit.  Co-lending will be done only for secured credit," says K Satyanarayana Raju, managing director (MD) and chief executive officer (CEO), Canara Bank. “And whenever 3 per cent of the portfolio sourced through a particular co-lending partner turns stressful, we will stop sourcing from that partner," he adds.

The narrative is similar at HSBC: It’s exploring co-lending to meet priority sector targets. For Hitendra Dave, CEO, HSBC India, it entails outsourcing a key component of banking — customer origination. “We would prefer to work with other lenders whose risk appetite, risk management, and customer selection criteria are similar to ours. Otherwise, it’s a no-go," he says.

The above ties in with last fortnight’s Reserve Bank of India (RBI) master direction on 'Managing Risks and Code of Conduct in Outsourcing of Financial Services’, which has been placed for public comments. It’s categorical that outsourcing of any activity by a regulated entity (RE) does not diminish its obligations, as also that of its board/senior management, who have the ultimate responsibility for the outsourced activity. REs must ensure the service provider employs the same high standard of care while performing the services as would be employed by them -- that is if the activities were conducted by the REs and not outsourced. It noted that stress is creeping through in some segments.

“Certain components of personal loans are recording very high growth. These are being closely monitored by the Reserve Bank for any sign of incipient stress,” said RBI Governor Shaktikanta Das while announcing the review of the monetary policy. Both the RBI’s master direction and Das' stance have to be read in with the central bank’s tough stance on corporate governance articulated in May this year.

In the details

On paper, the co-lending model is a winner. But it calls for a high level of coordination: Policies would have to be agreed upfront between banks and NBFCs. Take vehicle finance, for example. Banks are more comfortable funding fleet operators and servicing largely out of branches; NBFCs are happier with new-to-credit commercial vehicle owners and fine with field decisions. 

When it comes to underwriting, friction points continue to exist. And what’s proving irksome are banks expecting NBFCs to adopt their policies, “which will make it no different from a business-correspondent structure”, as the head of an NBFC puts it.

Shachindra Nath, vice-chairman and MD, U GRO Capital, feels co-lending would take off in a much bigger way if NBFCs are allowed to provide FLDGs (first-loss default guarantees) — a back-up offered by digital platforms (or, other unregulated entities) as a guarantee to lenders (regulated) on whose behalf they source business. “While it involves a cost to us, the systemic gains will be that of more credit being given out. The difference in credit process between banks and NBFCs can be bridged if FLDG is allowed,” he explains. This may not fly with Mint Road as it has never been comfortable with the option: The fear being that REs (read banks) will seek comfort through FLGDs (rather than put their skin in the game), and this will run counter to its view on outsourcing in the master direction.

Another unresolved issue is pricing how to marry the low cost of funds from banks with the lower cost of operations of NBFC, and pass this on to borrowers through a blended rate. It was felt that the pricing of such loans would get cheaper as 80 per cent of the exposure is with banks whose cost of funds is cheaper. “But loans are priced to risk, and banks slap a risk premium on co-lent loans over and above charging premium on credit to NBFCs as many are hovering close to their sectoral exposure limits,” points out Aseem Dhru, MD & CEO, SBFC Finance.

There is also confusion over the RBI’s position that “NBFCs shall give an undertaking to the bank that its contribution towards the loan amount is not funded out of borrowing from the co-originating bank or any other group company of the partner bank”. Banks have current and savings accounts; NBFCs are funded through debentures and commercial papers. “To say that NBFCs must not be funded by their partners would mean we have to tie up funds from another lot of banks (with whom co-origination will be ruled out) unless these limits are vacated”, points out an NBFC official. As it calls for a fine balancing act.

For now, yours and mine are fine. Not ours.