Co-lending, a collaborative effort between banks and non-banking financial companies (NBFCs), has emerged as a significant mechanism to address the liquidity challenges faced by the unbanked and underserved segments of the economy. The history of co-lending dates back to the introduction of the co-origination of loans by banks and NBFCs in 2018. Early partnerships, such as the agreement between ICICI Bank and Small Business FinCredit India in January 2019, marked the inception of co-lending in the Indian financial landscape. Since then, the co-lending model has continued to recognize the untapped potential of banks, which possess strong liquidity reserves. As this ecosystem strengthens, it is expected to bridge the gap between accessibility and the MSME ecosystem in India. Subsequent tie-ups between prominent financial institutions, including the Edelweiss Group, Central Bank of India, and Bank of Baroda, have illustrated the growing momentum of co-lending, reflecting its increasing significance in driving credit flow to the MSME sector.
The unforeseen pandemic and subsequent lockdowns severely impacted the MSME sector, with 67% of MSMEs temporarily shutting down for three months or more in FY21, and over half of all MSMEs experiencing a decline of more than 25% in revenues. In response, the RBI amended the 2018 framework of co-origination in 2020 to create a more flexible model, which has since shown promising results. Co-lending emerged as a solution to ease the liquidity crisis and is expected to play a significant role in promoting financial inclusion and reducing regional disparities. For banks, partnering with NBFCs allows them to lend more funds to various sectors and regions.
Understanding the regulatory framework and operational aspects of co-lending is essential to grasp its functioning. The key features of the Co-Lending Model (CLM) as outlined by the RBI include the scope, customer-related issues, risk-reward mechanisms, and the 80-20 split. These features aim to enhance the flow of credit to the unserved and underserved sectors of the economy. The impact of co-lending on the MSME sector has been substantial, with significant disbursements occurring through co-lending deals. In FY22, disbursements reached nearly ₹5,000 crore through co-lending partnerships. The exponential growth of these partnerships and substantial disbursements reflect the model's increasing significance in driving credit flow to the MSME sector.
According to a recent Ernst and Young study, India has close to 64 million MSMEs, surpassing China (44 million) and the USA (32 million), showcasing the great potential to contribute to India’s GDP. However, credit penetration stands at only 14%, which is the lowest compared to 37% in China and 50% in the USA. This is particularly alarming, especially as the sector navigates external headwinds. Economic uncertainty, coupled with a competitive market scenario, could stifle the growth of MSMEs. Establishing a robust co-lending ecosystem could effectively address many of these challenges. Financial inclusion of the unbanked and underbanked population is key to achieving inclusive economic growth in India, and the accessibility of credit on demand is one of the crucial components in this pursuit.
While the co-lending ecosystem is extremely promising, it remains in its nascent stages in India. Issues such as technological integration, differing risk perceptions between lending partners, and slower acceptance of the model by larger NBFCs must be addressed diligently. Despite these challenges, the prospects for co-lending are encouraging. It has the potential to enhance the efficiency of Direct Selling Agents (DSAs), and the market for digital lending platforms is expected to reach USD 26.6 billion by 2028. The regulatory innovation of the Co-Lending Model 2 (CLM2) and its role in combining the strengths of fintech NBFCs with the lower cost of funds in the banking system are anticipated to further drive the growth of co-lending.
To further enhance the co-lending ecosystem in India, there is an urgent need for better infrastructure. The rapid implementation of digital infrastructure and credit information analytics has bolstered lender confidence in MSME credit expansion. A robust technological infrastructure and effective risk mitigation strategies are crucial for ensuring the sustained growth and success of co-lending within the Indian financial ecosystem. To make this initiative successful, products and platforms must be well-equipped to manage the hybrid borrowing model. With India’s technological expertise, there is potential to create one of the strongest co-lending ecosystems in the world, significantly increasing credit penetration by threefold for the Indian MSME sector and setting an example in financial inclusion. As we progress and expand both horizontally and vertically, the backbone of our economy will be defined by the success of small businesses alongside large-scale conglomerates. The ripple effect of this ecosystem is immeasurable and cannot be overlooked while creating the vision of ‘Viksit Bharat 2047.’
In conclusion, co-lending has emerged as a game-changer for financial inclusion, addressing the liquidity challenges faced by the unbanked and underserved segments. Continued collaboration between banks and NBFCs is crucial for further expanding the reach of co-lending and fostering inclusive growth within the financial ecosystem. The transformative potential of co-lending in driving financial inclusion is evident, and its role in addressing the liquidity challenges faced by these segments is paramount.
Views are personal. The author is CEO & Founder of Lendingkart