Bank credit act as fuel for economic growth. The funds pumped into the economy helps boost investments and demand which in turn results in the increased returns. However, both private and public sector banks have strict eligibility criteria, making access nearly impossible for the financial weaker section of the society.
In order to finance the needs of these individuals and small businesses, NBFCs stepped in to fill the credit gap. But the IL&FS crisis of 2018 led to liquidity woes that restricted funding and valuation of players in the segment. The government has taken a number of initiatives to help the NBFC sector get back on its feet, with the notable co-origination scheme announced on 1st August 2018 being seen as a potential solution to this challenge.
Under this scheme, all scheduled commercial banks (excluding Regional Rural Banks and Small Finance Banks) can engage with NBFC-ND-SIs for priority sector lending. Priority sector loans refer to the credit disbursed to the underserved sections of the economy, without adequate, timely access to such funds. The solution helps NBFCs get the funding they need, banks meet the priority sector lending quota and customers access funds at a cheaper rate.
Benefits of the new model include:
- Risk Sharing- The model dictates that NBFCs take on a minimum of 20% of the risk exposure to ease their burden through the ongoing liquidity crisis. The sector could also leverage the risk management models and techniques developed by the partner banks to fortify their own.
- Lower Cost of Borrowing- The respective fixed interest rates, in combination with the risk sharing ratio, is used to arrive at a single rate that is offered to the borrowers. Alternatively, the weighted average of the interest rates, aligned with the proportion of contribution, can also be used to arrive at the interest rate. Thus, the cost of borrowing becomes significantly lower than generally offered by NBFC.
- Visibility and Valuation- NBFCs can also leverage the partnering banks’ presence and reputation in tier 1 and tier 2 to build on their visibility to attract new customers. The listed institutions valuation rises and falls with its reputation and this model could help them regain the trust of both lenders and borrowers.
- Fresh customer base: The blended rates and risk sharing allows NBFCs to target new customers with unique, innovative solutions. However, NBFCs need to protect their existing customers base through a clear segregation of existing products and the solutions offered under the co-origination model.
Ensuring that the model works!
- Process- Although putting a process in place can be a tedious task, having one in place is critical to ensure the delivery of a seamless experience. The NBFCs should explicitly define the roles and responsibilities of each party throughout the customer journey
- Technology- Technological integration of the entities involved will determine the success of such an arrangement. Having an established standard protocol to enable communications between the systems can go a long way.
- Reporting and compliance- Reporting standards and compliances of the two sectors should be settled to ensure proper governance and management of risks.
Capri Global Leads by Example
Capri Global Capital Limited is one of the NBFCs that have adopted this model by partnering with the State Bank of India (SBI) to boost the flow of credit to the MSME sector. Both CGCL and SBI will jointly contribute the credit to finance loans between Rs 10 lakhs and 50 lakhs in tier 2 and tier 3 cities.
Under the agreement, CGCL is responsible for the sourcing, servicing and collection of the repayment. The MSME sector attributes for up to 60% of the institutions’ standalone AUM and this model will enhance lending which is the key to financial inclusion and the growth of the ecosystem.
Whether the end goal is to expand their product portfolio or support the priority sector, the co-origination model can help target new market segments. But the benefits of the model go well beyond identification of market segments to serving them and driving the development of the country.