Indian banks / Financial Institutions have sufficient funds for lending at lower interest rates, but meagre outreach through it’s branch network hamper their ability to extend credit to the unserved and under-served segments of population. Most of the un-served and under-served population are engaged in sectors which were neglected by Banks / FIs. These sectors were identified by Government and termed as ‘Priority Sector’ which have national importance and have been given priority for development. Priority sector refers to those sectors of economy which may not receive timely and adequate credit in the absence of this special dispensation. Further, these sectors impact large sections of the population in general and weaker sections in particular, they are employment intensive, meets the basic needs of a common man and Productive sectors of the economy which contributes more to GDP of a nation.
In the National Credit council meeting held in July 1968, it was emphasized that commercial banks should increase their involvement in financing Priority Sectors. Accordingly, the description of Priority Sectors was formalized in the year 1972 as per Informal study group on statistics relating to Priority Sector Advances constituted by RBI in May 1971.Although initially there was no specific target fixed in respect of Priority Sector lending, inNovember 1974 banks were advised to raise the share to Priority Sector in their aggregate advancesto the level of 33.33% by March 1979.Subsequently, on the basis of the recommendations ofthe Working Group on the Modalities of Implementation of Priority Sector Lending and the TwentyPoint Economic Programme by Banks, all commercial bankswere advised to achieve the target of Priority Sector lending at 40% of aggregate bank advancesby 1985. Now, presently, the computation of Priority Sector targets/sub-targets achievement will be based on the ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposures, whichever is higher at the corresponding date of the preceding year. Presently, eight sectors were identified as Priority Sector. They are
- Export Credit
- Social Infrastructure
- Renewable Energy and
Reserve Bank of India and Commercial banks are exploring and innovating several options for meeting the regulatory requirement and Government of India’s guidelines. In addition to direct lending to Priority Sector by banks to individuals, many ways and means were explored to reach the unserved & underserved population using different methods of lending like
- Joint Liability Groups
- Self Help Groups
- Engaging the services of Business Correspondents (BCs) to provide various services such as identification of borrowers, collection, recovery, follow-up and such other ancillary services
- On-lending to eligible intermediaries like Micro Finance Institutions. On-lending means loans sanctioned by banks to eligible intermediaries for onward lendingonly for creation of Priority Sector assets
- Co-lending by banks through NBFCs
Non-Banking Financial Companies (NBFCs) are having advantage due to their agile nature and less stringent regulation, enjoy greater penetration into the market but frequently suffer from liquidity crises.NBFCs can lend and also can make investments. As such their activities are similar to that of banks. However, NBFC cannot accept demand deposits, do not form part of the payment and settlement system and cannot issue cheques drawn on itself. Further, deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs.
Co-lending refers to a collective operation of two or more entities in the financial sector. To address the challenge of the rising credit gap within the unserved and underserved economy, RBI has introduced this new model of partnership between banks and NBFCs on 5thNovember 2020 for Co-Lending to the Priority Sector.
With an object to improve the flow of credit and also to make funds available to the un-served and under-served sectors at an affordable cost Reserve Bank of India rechristened co-origination of loans by banks and NBFCs for lending to Priority Sector as “Co-Lending Model” (CLModel).
Banks do have plenty of funds at lower cost for the purpose of lending while Non-Banking Financial Companies (NBFCs) have the infrastructure for greater reach to un-served and under-served population.
RBI has provided greater operational flexibility under Co-Lending Model by permitting banks to co-lend with all registered NBFCs (including HFCs) based on a prior agreement, but with strict regulatory guidelines on outsourcing, Know Your Customer (KYC) and minimum share of the individual loans by NBFCs in their books. The main advantage to Lending Institutions is that banks can claim Priority Sector status in respect of their share of credit while engaging in the CLModel. However, CLModel shall not be applicable to foreign banks with less than 20 branches in India.
Salient features of Co-Lending Model
- Master Agreement:
Banks & NBFCs are required to enter a Master Agreement for implementing the CLM. Master Agreement may contain necessary clauses on representations and warranties which the NBFC shall be liable in respect of share of loans taken into its books by the Bank. If the Agreement entails a prior, irrevocable commitment on the part of the Bank to consider share of individual loans already originated by the NBFC, the arrangement must comply with the extant guidelines on Managing Risks & Code of Conduct in Outsourcing of Financial Services by Banks
- KYC guidelines:
Banks are also required to comply with the directions of KYC to rely on customer due diligence done by a third party
- Escrow account:
CLM specifies the opening of an escrow account for the purpose of disbursals, collections, etc. The co-lending banks & NBFCs were obligated to maintain every borrower’s account for proper exposures assessment
- Minimum Holding Period:
If Bank can exercise its discretion regarding taking into its books the loans originated by NBFC as per the Agreement, the arrangement will be similar to a direct assignment transaction. Accordingly, the taking over bank shall ensure compliance with all the requirements in terms of Guidelines on Transactions Involving Transfer of Assets through Direct Assignment of Cash Flows and the Underlying Securities with exception of Minimum Holding Period (MHP) which shall not be applicable in such transactions undertaken in terms of this CLM. The MHP exemption shall be available only in cases where the prior agreement between the banks and NBFCs contains a back-to-back basis clause and complies with all other conditions
- Loan agreement:
NBFC shall enter into a loan agreement with Customers (borrowers).All details of the arrangement including roles and responsibilities of NBFC and Bank shall be disclosed to customers and their explicit consent should be obtained.The borrower may be charged an all-inclusive interest rate as may be agreed by NBFC and Bank conforming to the agreed guidelines.Guidelines relating to Customer service, Fair practices code and other obligations of Bank & NBFC shall be applicable. NBFC should be able to generate a single unified statement of the Customer, through appropriate information sharing arrangements with the Bank.
- Grievance redressal:
Necessary arrangements for Grievance redressal must be made by NBFC and Bank to resolve any complaints registered by a borrower with NBFC within 30 days, failing which the borrower would have the option to escalate the same with the concerned Ombudsman for NBFCs or the Customer Education and Protection Cell (CEPC) in RBI or Banking Ombudsman.
- Monitoring & Recovery:
Banks and NBFCs shall maintain individual borrower’s account for their respective exposures. However, all transactions (disbursements/ repayments) between the banks and NBFCs relating to CLModel shall be routed through an escrow account maintained with the banks, in order to avoid inter-mingling of funds. Banks and NBFCs shall establish a framework for monitoring & recovery of loans. Banks and NBFCs shall arrange for creation of security and charge as per agreed terms. Banks and NBFCs shall adhere to the asset classification and provisioning norms as per regulatory guidelines. Loans under CLModel shall be included in the scope of internal and Statutory Audit within Bank & NBFC as per internal guidelinesand regulatory requirements. Assignment of a loan by Bank or NBFC to a third party can be done only with mutual consent
Bank &NBFC shall have a Business Continuity Plan (BCP) to ensure uninterrupted service to their borrowers till repayment of loans under CLModel
Advantages of CLM
- CL model is helpful in increased credit flow to healthy Priority Sectorloans
- Contribute to the country’s financial inclusion imperative towards building an AtmaNirbhar Bharat
- CLModel is applicable not only to NBFCs but also Housing Finance Companies
- Lower Credit risk
- Convenient repayment schedule to the ultimate borrowers
- aim is to reach out to a large section of society by offering easy, convenient, and efficient credit solutions
- CLModelcan be instrumental in increased consumption there by providing for robust growth in the economy
- CLModel provides fund flow in smoother and seamless way for NBFCs
- As it is with collaboration, both organisations i.e., Banks and NBFCs mutually make progress
- Due to CL model, flow of credit reaches the unserved and under-served population
- Lot of potentiality for Digital products
- CL model will be instrumental in marching the country towards the vision of a $1-trillion economy
- CL model will help MSMEs to avail customized lending solutions
- competitive rate of interest
- Significant reduction in processing and sanction of loan applications leading to reduced turn-around time
- Allows traditional lenders to associate with Fintech firms
- Provide an excellent avenue for NBFCs to grow their assets under management
- Sharing the risk and returns
Reserve Bank of India’s Co-Lending Model has been around for a while now, but it has many
- C L Model is not applicable to Small Finance Banks, Regional Rural Banks, Urban Cooperative Banks and Local Area Banks
- CLModel shall not be applicable to foreign banks with less than 20 branches
- 80% of the total credit risk under this model shall be on the bank’s loan book
- CLModel is just old wine in new bottle as it is an upgraded model of Co-origination of loans scheme
- CLModel will be successful only when there is good team dynamics exist between Banks & NBFCs
- There may be good number of operational issues for both Banks & NBFCs
- CL model may not be suitable for all sectors of the economy
- NBFCs are required to maintain at least of 20% share of individual loans in their books due to which many tech savvy companies cannot participate
While realising the needs of unserved and underserved, Banks has to keep in mind the increased expectation of it’s existing Customers by using Digital technology to resolve many operational issues
CLModel provides an alternate opportunity to banks to give more funds and allows to link with Fintech firms that have greater reach of un-served and under-served population.The model also provides a platform for NBFCs to grow. It will help NBFCs to mitigate the funding crisis and capital constraints and take part in the sustainable credit to the priority sector along with Banking Institutions. Banks & NBFCs have to make sure that there are efficient systems placed to implement proper Due Diligence. Effective functioning of NBFC required to deal and negotiate with the borrowers. Innovative models like CLModel will evolve and grow to fulfil the credit requirements of the Priority Sector segments in particular and Financial Inclusion in general.