Co-Lending - Bank Credit Finds New ways to Reach Small Enterprises

What is Co-lending?

Co- Lending in simple words is joint lending to a borrower by 2 (or more) lending institutions.

Co-lending has been around for a while and gaining traction after the RBI came out with a set of
guidelines on co-lending in September 2018. For a borrower it is like renting a car which has been
made partially by Maruti and partially by Hyundai. Both car makers take responsibility for their part of
the automobile respectively!

What Led to the Growth of Co-lending?

One will recall the word co-opetition wherein competitors came together to collaborate on a product.
One example that comes to mind is that of Sony and Samsung. In 2004, Sony Corp. entered into a
joint venture (JV) with its fierce competitor Samsung Electronics to develop and produce LCD panels
for flat-screen TVs. Co lending has a similar connotation- collaboration among lenders,

The rise of Fintechs (technology driven lenders), saw these nimble entities picking up market share in
the micro and small business category from the traditional banks. The methodology and approach to
deal with small ticket loans was such that larger traditional lenders (Banks and large NBFCs) found it
difficult to emulate .This was largely due to the risk policies designed for document and collateral
based lending, slow decision making and higher cost structures that exist in these places. At the same
time the Fintechs needed capital to grow. This created a win-win opportunity for the Fintechs to grow
their business and for the banks to acquire new business in a more efficient manner.

The need for banks to ensure minimum disbursement to the priority sector lending ( and within it ,
disbursement to MSME enterprises) is also key driver for banks to explore co-lending .The RBI
circular was a step in that direction to give clarity to the lenders.

How does Co-Lending Work?

Usually a Fintech (small tech driven NBFC) enters an agreement with a larger bank or NBFC where
each party is a co-lender in the arrangement with rights and obligations of each party defined.

Origination:

The Fintech is responsible for sourcing new business which could be region specific or product
specific or both. The Fintech does the collection of application form and data collection. KYC checks
and also does the initial underwriting based on jointly agreed credit standards. As such, the Fintech is
the face or the front end of the co-lending arrangement.

The credit memo is sent to the larger lender’s credit underwriter for confirmation. Once, doubts if any
are clarified, fintech issues sanction letter to the borrower. The sanction letter may have logos of both
the co-lenders as well signed by their authorized signatories.

Loan Booking:

The loan to the borrower is split in a pre-agreed ratio usually 80:20 wherein 80 % of the loan amount
is booked by the larger lender while 20% is on the books of the smaller co-lender.
Disbursement:

The co-lenders place their respective loan amounts in an escrow account. From this account 100% of
the loan is disbursed to the borrower’s account.

Interest and Fees:

Each lenders works at their agreed interest rates based on cost of funds. The bank will obviously have
a lower rate than the Fintech. However, the customer is offered a single blended rate of interest. The
interest income is also split in the ratio of the loan amount. Similar rules are applied to processing fees
as well unless pre-agreed for a specific fee sharing ratio.

Collection:

The borrower is required to pay into the escrow account (vide NACH/ECS) from where the amounts
are apportioned and sent to the lenders’ respective accounts in the loan ratio.

As stated earlier, the Fintech is responsible for sourcing, document collection, and relationship
management with respect to the loan. The collection responsibility also initially lies with it. However,
any overdue amount reflects in the loan ratio of the respective lenders. Often the fintech enters in a
separate agreement with the bank whereby the bank appoints it as the collecting agent under the co
lending agreement.

Loan documentation with Borrower:

A tripartite loan agreement is executed with rights and obligations of each party are defined. The
borrower is hence made fully aware of the arrangement but for the sake of simplicity, it is assured that
only one lender will interact (normally) for all loan servicing issues. Often dealing with multiple lenders
creates resistance among borrowers but co-lending is fast gaining acceptance.

Conclusion:

Co-lending is a rising trend and has implications for lending software suites to adapt to the
requirements of this new process. It also throws up new challenges and opportunities for product
companies.