Sharing risks and rewards: How Co-lending can be win-win option for Indian credit market post-coronavirus

Banks are gearing to align themselves with potential changes in customer’s borrowing needs and repayment capabilities.

RP Singh

With the country witnessing multiple phases of lockdowns and unlocks, various sectors of the Indian economy have been hit hard. While businesses and individuals are in need of fresh credit due to falling revenues and cash reserves, banks, NBFCs, and HFCs themselves have been affected by the pandemic. Banks are gearing to align themselves with potential changes in customer’s borrowing needs and repayment capabilities. They are assessing their position to ensure sufficient liquidity by identifying key risks from both supply and demand perspectives, such as additional drawdowns in commercial and retail businesses and large withdrawals. While rolling out fresh credit, lenders now need comprehensive risk identification, continuous monitoring, and risk mitigation approaches to identify customers with higher vulnerability to the impact of COVID-19 outbreak and anticipate deteriorating creditworthiness.

To keep the banking system strong while fighting the Covid19 pandemic, we need more collaboration among various stakeholders to unlock higher business value and deliver enhanced customer experience. Co-origination of loans is one such collaboration model that is expected to transform credit delivery in the times to come.

What is Co-lending?

The Co-lending of loans provides a unique opportunity for formal lenders to come together and share their synergies to create a winning proposition for all the stakeholders. It enables banks, Non-Banking Finance Companies (NBFCs), and Housing Finance Companies (HFCs) to enter into an arrangement where the risks and rewards are shared by all parties to the co-lending agreement throughout the lifecycle of the loan, as per a pre-decided ratio.

NBFCs and HFCs often face challenges in getting access to funds for lending purposes at reasonable costs, which in turn results into higher interest rates for their borrowers; whereas large commercial banks may find it difficult and expensive to extend their reach to certain locations, where the NBFCs & HFCs have a stronger presence. Co-lending helps in bridging these gaps.

Why co-lending?

The co-lending model empowers multiple stakeholders of the lending ecosystem. While NBFCs and HFCs can leverage their strong presence in local markets, commercial banks have the availability of funds for credit disbursal. This becomes even more relevant in the current scenario where many NBFCs are battling against the liquidity crunch. In large states like Maharashtra where NBFCs were deploying an average of INR 560-610 billion since Q1 FY18, the figure dropped to INR 393 billion in Q1 FY 20. Currently, the total bank lending in the system stands at around INR 97 trillion out of which the total NBFC book is only around INR 24 trillion.

Another advantage of this partnership is that NBFCs and HFCs have mastered the art of assessing the creditworthiness of certain niche customer segments, which the banks have been ignoring, primarily due to differences in their core target segment and credit risk management approach. In FY19, NBFCs had a 30% share in outstanding retail loans, while public sector banks had a 39% share and private banks had 26%. As far as the share of new retail loans to new credit customers is concerned, NBFCs had a lion’s share of 56% by volume and 40% share by value in FY19, thereby completely outperforming public and private sector banks.

The NBFCs use a number of innovative mechanisms for credit risk assessment including usage of non-traditional sources of data, observing an individual’s modus operandi and cash-flow at work, building customized scorecards, etc. for both small-ticket retail and MSME segment. This is a big pie for banks to look forward to. Last year, the central bank also came up with guidelines for lending to priority sectors through co-origination of credit.

But while the RBI guidelines highlight co-lending as an initiative to propel priority sector lending, the model has a much broader potential to go beyond just lending to the priority sectors. The model can also go well beyond a typical bank and NBFC partnership, presenting a world of infinite opportunities. A commercial bank may tie up with multiple NBFCs or an NBFC may tie up with another NBFC, depending upon the business need. In fact, banking giants like the State Bank of India and Bank of Baroda have already tied up with some of the leading NBFCs across the country. In another example, the recent partnership between Capital Float and Japan’s Credit Saison indicates how NBFCs are also coming together for greater access to the lending market.

Technology holds the key

While the co-lending model is a winning proposition for all stakeholders, it demands extensive use of robust technology to simplify the operational challenges. While NBFCs / HFCs will be the front end for customer servicing, all decisions, transactions and funds require multi-directional information flow at various points between the banks and NBFCs, highlighting the urgency for mature technology solutions.

Financial institutions need to carefully evaluate if their current technology systems are capable of handling the challenges posed by the unique requirements of this arrangement, some of which are mentioned below –

Due to COVID-19, it might become cumbersome for banks to determine the adequacy of loan-related collaterals available with them and make requisite provisioning. Additionally, there may be new disclosures required in financial statements and computation of capital adequacy for Covid-19. This becomes even more complicated when the loan is co-originated by two parties and hence effective use of technology will help drive the much-needed model.

KYC (Know-your-consumer) & AML (Anti-money laundering) compliance is an important part of credit disbursal process. Since co-lending involves multiple lenders, the compliance check requires a seamless sharing of customer data between them. The assessment of creditworthiness is another critical aspect. Co-lending requires the configuration of one’s credit assessment module to also consider the additional decision parameters from the partner’s credit risk team.

Co-lending enables both the partners to price their portions of the loan as they want. This requires the configuration of multiple repayments and accounting policies to arrive at the final repayment schedules for the customer. Since each participating lender follows its own provisioning and reporting requirements as per the applicable regulatory guidelines, the lending parties need configurable loan views from the perspective of multiple stakeholders, i.e. banks, NBFCs / HFCs as well as customers.

Both the partners need to agree on standard processes while aligning their businesses to the other partner’s approach in order to move forward. The co-lending model will test the agility, configurability, and integration capabilities of technologies behind the lending systems.

What lies ahead?

From a broader perspective, co-lending can be seen as the starting point of platformification of lending where non-banking financial institutions are consolidating their presence at the front of customer engagement on behalf of banks and lending moves further beyond the bank branches. However, it is important to remember that the long-term success of partnerships based on co-lending will largely depend on achieving tangible business outcomes, which would require the financial institutions to work very closely so as to seamlessly integrate and streamline their operations.

At a time when we are witnessing the biggest disruption of our lives in the form of a pandemic and businesses across the globe have been badly hit, co-lending can provide the much-needed impetus with greater access to credit. It is a win-win situation for all as NBFCs and HFCs get easy and cheaper access to funds, banks extend their business reach to new markets/segments and consumers get easier and better access to much-needed credit at lower costs.

RP Singh is CEO of Nucleus Software. Views expressed are the author’s personal.