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Adding to our series of webinars on Digital Lending Guidelines (DLG), we did our first ‘Co-lending 101’. And yes, we wrapped up an insightful session!
From the fundamentals of the co-lending model (CLM) for building more clarity around it to what it holds for the future, the expert panel had a holistic discussion.
On the panel were Aditi Olemann from Cashfree Payments, Apurva Jain from Yubi, Pankaj Chaudhary from Niyogin, Kshitij Puri from ZipLoan, and Amit Maurya from Ring.
The webinar pivoted around the meaning of co-lending, its various dimensions and challenges. It also revolved around the impact of the RBI’s DLG (Digital Lending Guidelines).
This blog is a synopsis of the same. It is a quick read for all businesses that are either venturing or have been operating in the co-lending space. Also, if you have a solution platform that supports a co-lending ecosystem in any way then this is a must-read!
So, without any delay, let’s get into the details.
What is Co-Lending?
Before we get into the specifics of the webinar discussion, let’s understand what co-lending is.
Co-lending is defined as a form of lending where two regulated entities provide lending services to customers. It is typically a bank and an NBFC but also two NBFCs that partner together. The two entities share the liability in different ratios as pre-agreed by them.
While co-lending as a form of lending has existed for several years, the advent of fintechs in the lending space has bolstered digital co-lending into a whole new league.
Key Takeaways: Co-Lending 101
The RBI guidelines outline the priority sector co-lending between banks and NBFCs. However, NBFC-NBFC co-lending is also quite prevalent in similar lines for non-PSL (non-priority sector lending).
Generally, First Loss Default Guarantee (FLDG)-based digital lending has been prevalent among non-regulated fintechs who partner with NBFCs to provide loans to their customers.
In this form of partnership, the Regulated Entity (RE) brings in the capital. While the non-regulated fintech brings in the customer, the risk is shared through an FLDG. However, with RBI streamlining digital lending over the last year, there is a growing trend of fintechs acquiring NBFC licenses, to enter the space of regulated co-lending.
Role of Lenders and Originators in Co-Lending
Pankaj Chaudhary opined that the role of the originator in co-lending is to acquire and service the customer. Simultaneously, the originator also ensures repayment at the agreed ROI. On the other hand, the lender is the one who puts in the larger portion of the money in the partnership. ‘What about risk sharing in such a partnership?’ Pankaj answers,
Risk participation should not lie fully with one partner but there should be a balance. Both partners must agree upon the risk-reward balance.
In addition, a tech-savvy efficient process that fuels business and growth is of paramount importance.
Also, how to choose the right partner or rather the right RE (regulated entity)? LPs (lending partners) should evaluate a product in isolation regardless of who is the originator. They should look at the product’s scalability and not whether the originator is a large entity or a small/thinly-capitalized entity.
Amit Maurya added that in non-discretionary and non-PSL sectors, one needs to have some sort of structure for FLDG. Whereas, for discretionary PSL, there can be no FLDG because the RBI does not allow any credit enhancement.
In non-discretionary co-lending, the dominant lending partner wants some comfort. This is because the originator or the sourcing partner primarily takes most decisions.
80-20 ratio is commonly seen between regulated entities getting into co-lending, but other ratios also exist. However, less than 10% is not recommended.
Challenges in Co-Lending
What lending partners have been looking out to solve is how they go about the whole lending business. They aim for being more efficient. They seek the capability of providing a more organised way of lending, from initiating to processing to managing.
Secondly, data sharing and data structuring safely and easily is something that they need to take care of. Moreover, it is an ongoing and real-time process.
Lastly but most importantly, they must store all this data exchange in a compliant way.
Apurva Jain highlighted the challenges that REs face when it comes to integrations for data exchange and the overall operational complexities. One-on-one integration is time-consuming and repetitive and if that fails, the whole process can fall.
Lending, an already complex process, doubles its complications with co-lending. The reason is that the two entities come with their own sets of criteria and policies with which they underwrite a borrower. Both parties need to configure their credit policies and credit filters when loan value passes on from the originator to the lender. For reporting and reckoning processes as well, they need to create parallel workflows according to the agreed terms.
This makes it very complex for two entities to work together and go live on co-lending. The critical role of lending platforms and payment service providers here is to help simplify operations. Also, they should make integration and go-live simpler for two REs getting into a co-lending partnership.
Co-lending Models
There are two co-lending models – CLM1 (Co-lending Model 1) and CLM2. In CLM1, both parties pool in money and disburse the loan. In CLM2, one party disburses and the other party reimburses. CLM1 is the preferred mode for most NBFCs getting into co-lending.
Also, CLM 1 can be for both PSL and non-PSL, however, CLM2 is only for PSL.
Co-lending is not a new concept and the RBI has been promoting it for a long time since credit penetration has been confined to limited regions and segments. However, after the fintechs came into play, the RBI encourages credit disbursement but also wants lenders to follow a framework.
It wants that the originator/sourcing partner should know its customers and NOT LEND just on behalf of the lender, Likewise, the lender must not pass 100% risk to the originator.
Also Read: Unlocking New Opportunities for Growth with Digital Lending
Payment Flow
The payment flow into the account of the borrower by the lenders is important to focus on. This depends on the type of lending arrangement that exists between two partners. For instance-
- If it is a 100-0 arrangement, then the handling of the money is the sole responsibility of the lender contributing 100% of the loan. This means that the lending and repayment must happen directly between the bank accounts of the lender and borrower. The originator must not touch that money
- When it’s a co-lending arrangement between two parties, a co-lend-escrow account is strongly recommended. The REs open an account in a bank, in compliance with the CC/OD guidelines, and they pool their money in the common account. A separate collection co-lend escrow is also created for repayments coming in for this partnership. Payment aggregators have an important role to play in the payment flows, both in disbursals (as a Technical Service Provider), and in repayments, in the capacity of a Payment Aggregator
Parting Thoughts
So, that was the summary of the enlightening session we had at the Webinar – Co-lending 101: The Road Ahead – How to Kickstart your Co-lending Journey.
Starting with the basics of what is co-lending and the RBI’s co-lending guidelines, we delved deeper into it. We have covered other aspects of co-lending in our previous sessions and look forward to doing it in future.
So, stay tuned and meanwhile, you can check out the full-stack digital lending solution for NBFCs and Fintechs by Cashfree Payments.
Key Terminologies
Frequently used acronyms, their full forms and meanings for your reference:
RBI: Reserve Bank of India
The RBI is the country’s central bank as well as a regulatory body that regulates and guides the Indian banking system. It lays down the norms according to which all banks or non-banking financial companies (NBFCs) must function.
NBFC: Non-Banking Financial Company
NBFCs are the institutions that provide financial services, similar to banks but do not have full banking licenses. Unlike banks, they can’t accept deposits and raise money through bonds or borrowing from banks. They also have fewer regulatory controls than banks. However, the RBI regulates both banks and NBFCs. They are also known as NBFIs (Non-Banking Financial Institutions).
RE: Regulated Entity
By REs or Regulated entities, we refer to banks or NBFCs that the RBI regulates.
FLDG: First Loan Default Guarantee
This is about the co-lending model between a fintech and an RE (banks/NBFCs). It is an arrangement where the RE is the lender and the fintech being the originator takes a guarantee of compensation to the RE up to a certain limit in case the borrower defaults. The RBI’s first set of digital lending guidelines states that the loan transaction must occur directly between the borrower and the RE’s account. It should be through any unregulated entity or third-party loan service provider such as fintech. So, with the FLDG model in crisis, fintechs look forward to acquiring an NBFC license.
LSP: Lending Service Providers
Lending Service Providers can be fintechs or any such third-party digital platforms that provide loans, credit lines and lending services to borrowers. As they are not banks/NBFCs themselves, they may lend to borrowers in connection with the REs. However, they help through their digital services in reaching out larger customer base and acquisition as well as faster and easy processing like underwriting and repayment of loans.
DLG : Digital Lending Guidleines
The RBI came up with Digital Lending guidelines that apply to all REs for lending purposes. Be it banks (commercial or primary/urban/state/district central co-operative) or NBFCs including HFCs (Housing Finance Companies) must comply with the DLG
PSL: Priority Sector Lending
Priority sectors are those sectors that the GOI and the RBI consider important for the development of the nation and give priority over other sectors. They implore the banks to dedicate funds to these sectors such as agriculture, education, housing, etc. for poor strata of the country. The rest of the sectors are termed as non-PSL.
