How co-lending is changing the credit landscape in India

Co-lending has helped unlock pools of capital lying dormant, as the cost of executing small ticket lending was traditionally expensive for larger lenders. Image: Prashanth Vishwanathan/Bloomberg via Getty Images

One of the most important tenets of financial inclusion is easy and on-time access to credit—at a reasonable cost, irrespective of geographical location. India is still a credit-hungry nation. This unmet credit gap serves as both a challenge and an opportunity for financial services providers.

Co-lending can solve India’s liquidity problem

The country’s fintech sector has played a pivotal role in bridging such gaps. Innovation in this space has surged, driven by favourable government policies on entrepreneurship, infrastructure and risk capital. Through emerging technologies, lenders have been able to design, launch, and distribute customised financial products at lower costs.

Digital lending is the fastest growing fintech segment in India, having attained a value of $110 billion in 2019, from just $9 billion in 2012. Dominated by fintech startups and NBFCs, this sector is expected to reach a value of $350 billion by 2023.

However, liquidity has always been an issue in such endeavours. Legacy banks have been reluctant to provide loans to avoid systemic liability. India’s debt capital markets have also remained in a nascent stage with conservative regulations.

This was until 2018 when the RBI put in place a framework for co-origination by banks and registered NBFCs for credit to the priority sector. The scheme was re-christened the “co-lending” model (CLM) in 2020, enabling operational flexibility for lenders, while requiring them to meet regulatory norms regarding KYC, outsourcing, and so on. However, the co-lending model acknowledges that India’s public-sector banks (PSBs) dominate a huge percentage of India’s liquidity reserves.

As per the RBI, by December 31, 2021, bank credit stood at $1.56 trillion. The entire banking system needs to be included in any discussion on the meaningful expansion of credit. By tapping into this liquidity, new-age lenders can scale at lower leverage. They can use the capital for experimentation and product development. At lower leverage, they can better handle cash flows, making them resilient to macroeconomic shocks in the future.

An off-balance sheet model helps lending companies tackle many issues, primarily ALM pitfalls, which led to a liquidity crisis in the NBFC sector in 2018.

Solving the problem of systemic liability 

The co-lending model has evolved into an effective liability strategy, where new-age lenders can use their capital more efficiently. They can simply find lending partners to scale products with a good product-market fit. The key to maintaining a healthy co-lending revenue model is ensuring that the off-balance sheet spread is greater than or at least equal to the on-balance sheet spread. This helps ensure that the liability strategy has no adverse impact on the P/L.

In addition, lenders can address the problem of systematic liability. Through partnerships between two regulated entities—NBFCs and big banks—the CLM ensures a high degree of compliance and customer protection.

New-age lenders must hold themselves to the same levels of compliance and regulatory overview as their legacy peers to be truly successful in co-lending. This will ensure that products and overall structures do not run into regulatory issues.

Technology enables credit access

The co-lending partnerships have been a win-win for all—banks, NBFCs, and the unserved and under-served sectors of the economy. Plus, NBFCs can now compete on the pricing front. Larger lenders, bearing a larger share of the loan at a relatively lower cost of capital, allow new-age lenders to price products at a lower rate. This makes credit affordable for the end consumer.

On the other hand, banks have been able to leverage technology in origination, credit assessment and collection. This includes the use of alternative data, real-time digital back-end operations, API-based underwriting, automation of KYC processes, reporting, e-documentation, and more. The coming together of these synergies has ensured seamless credit flow to the under-served.

In simple terms, larger lenders have been able to extend loans to borrowers whom they would have otherwise rejected, leading to greater financial inclusion. This has contributed to breaking the vicious cycle wherein banks weren’t keen to extend small-ticket loans to individuals without a credit history. And with no access to loans, these individuals would have no way to build their credit scores.

Co-lending has helped unlock pools of capital lying dormant, as the cost of executing small ticket lending was traditionally expensive for larger lenders.

Unlocking a $1 trillion digital lending opportunity

In 2021, India recorded the highest growth in cellular broadband data usage, with 4G data recording an increase of 31 percent. Mobile broadband subscribers have more than doubled between 2016 and 2021.

With the digital divide narrowing at one of the highest rates in the world, India is poised to generate $1 trillion worth of economic value from the digital economy by 2025. A 2018 BCG report forecasted that total retail loans disbursed digitally could reach a value of $1 trillion by 2023.

Given this backdrop and the benefits of CLM, India is poised to solve its multi-trillion-dollar liquidity issues in the coming years. Strong structural incentives will encourage financial players to come together and meet the growing credit demand with success.

The writer is CFO of Capital Float.

The thoughts and opinions shared here are of the author.