‘Co-lending’: A partnership model to solve India’s $1 trillion credit gap

What co-lending does so effectively is to solve two related issues of utmost importance—liquidity and systemic stability. On the liquidity front, it acknowledges that any meaningful expansion of credit has to come from the banking system at the back end. Our debt capital markets are still nascent, with conservative regulations and a dearth of market makers or participants.

Meanwhile, 60 percent of the country’s liquidity reserves reside within the public sector banks (PSB) system alone. New-age lenders must tap into this liquidity to scale, and an off-balance sheet model obviates many of the growing pains of accessing wholesale debt capital, such as ratings, vintage, and profitability. In addition to legitimising such partnerships, co-lending also offers a framework for implementing them, which could over time evolve into a set of standards that eliminate the typical friction in lender-bank partnerships.

Systemic stability is where co-lending truly scores as a model. As a partnership between two—albeit differently—regulated entities, i.e. a bank and an NBFC, it ensures a high degree of standardisation, compliance, fiduciary care, and customer protection. Borrowers are underwritten not once, but twice and by two different entities, and risk governance is a mutually reinforced exercise with adequate checks and balances. Co-lending also functions as a superior form of market-making for debt asset generation, with mandatory skin-in-the-game for the originator and risk-sharing through the 80:20 mechanism enshrined in the RBI’s guidelines. Additionally, a co-lent loan portfolio is one where asset and liability durations are perfectly matched, avoiding many of the ALM pitfalls that wrecked several non-bank lenders during the 2018 IL&FS crisis.

Learnings from recent years of co-lending make it clear that technology is essential for the model’s inherent scalability. In a world of instant digital credit, real-time digital back-end operations are an equal necessity. API-based underwriting, the digital exchange of data, e-documentation, and automated reporting and flow of funds are crucial building blocks for co-lending to work successfully. Much like a securities exchange or online marketplace, bilateral and larger co-lending platforms must be built from the grounds up as “tech first”. Once accomplished, these can prove to be highly extensible, supporting everything from a 24-hour Rs 5 lakh MSME loan to a two-minute consumer checkout purchase.

Once the technology is in place, successful co-lending partnerships come down to shared risk DNA. Digital credit products, in particular, often include large datasets at the time of application, automated credit policies, and iterative risk management models. Achieving alignment on these is important for every partnership. But even more critical is having a shared set of principles around risk management that can form a common basis for navigating changes in the macro-environment as they happen. Major discontinuities such as the impact of COVID last year can be challenging for any lender to manage individually; managing through these as a partnership is even more important.

Overall, there are many reasons to be bullish on co-lending as the model of the future for credit deployment in India. A recent BCG-Google report projects the mass market digital lending opportunity to reach Rs 1 trillion over the next five years. COVID will have accelerated that journey, fast-tracking consumer digital adoption over and above the pre-existing tailwinds of mobile phone penetration, cheap data, digital identity and payment rails. Given this backdrop, liquidity is the multi-trillion-rupee problem to solve over the coming years. While other solutions may nibble at the fringes of this, co-lending tackles the biggest prize of all—the massive liquidity inherent in India’s banking system today, and the strong structural incentives for players to work together to deploy this.