How co-lending can provide a fillip to MSME credit flow

Over the last two years, MSMEs have been proven key for the consumer market during the economy in terms of last-mile delivery, community support and even encouraging adoption of digital technology. This happened despite the challenges they’ve faced and continue to face in the wake of the market downturn to maintain cash flow and access working capital while dealing with supply and labour chain disruptions. It is no surprise that MSMEs have emerged as a backbone for global economies, especially in emerging markets like India.

However, despite the promise they hold and their significance within our economic framework, they struggle to access credit, which hinders their ability to navigate volatile market dynamics. According to a survey done by SIDBI, 67% of MSMEs in India were temporarily shut for three months or more in FY21 and over half of all MSMEs saw a decline of over 25% in revenues.

In such a scenario, NBFCs and especially digital lenders remain the go-to driver for new credit disbursals for the country’s underserved retail and MSME market. According to a report by PWC, the NBFC lending book has grown at nearly 18% driven by a deep understanding of target customer segments, use of technology advances, lean cost structures and differentiated business models to reach credit-starved segments. However, even as NBFCs play such an integral role in solving these issues, a lot of NBFCs are in a tight spot in terms of availability of capital. In order to cushion the impact of the pandemic on vulnerable sections of the society, the Reserve Bank of India (RBI) revised its 2018 framework for co-origination of loans into a more flexible framework of co-lending model (CLM) in 2020. This was done with the intention to enhance flow of credit to underserved sectors of the economy (especially MSMEs in smaller towns), by leveraging the lower cost of funds from banks and greater reach of NBFCs.

Co-Lending: A Symbiotic Relationship

Co-lending helps both banks and NBFCs collaborate and take advantage of their respective strengths to deliver a holistic experience that benefits all stakeholders in the value chain. From a customer standpoint, such arrangements improve access to capital and reduces the time taken for loan disbursal. Co-lending enables NBFCs to compete on the pricing front and banks get the benefit of the last mile reach, access to new product lines, speed of execution and strength in collections. This symbiosis is poised with massive opportunities with expectation of about Rs 300 billion to be disbursed by FY23 itself. Owing to the ubiquitousness of NBFCs in the country, this arrangement has led to an increase in first-time borrowers in India which has allowed for increased liquidity and credit penetration.

Even from a regulatory perspective, RBI has mandated all banks to lend a portion of their net bank credit (NBC) to some identified priority sectors in the economy. Co-lending arrangements allows for banks to easily fulfil sourcing requirements for such loans which in-turn benefits the economy in general.

Future Implications

While in theory this could turn out to be the veritable fillip that the underserved MSME credit segment requires, a large population of NBFCs i.e., digital lenders have been left in the shadows. A report by the McKinsey Global Institute previously estimated that digital finance would add $3.7trn to the GDP of emerging economies in the years leading up to 2025. However, most fintech lenders, given their lower vintage, are in the BBB rating group, and public sector banks are not co-lending with them. Interestingly, ratings should have little consideration in such direct on-book arrangements since the balance sheet of the NBFC does not intermediate these loans. Hence there would be merit in PSBs adopting a graded criteria and a first principles approach, especially given that the PSBs get to exercise granular policy control over these co-lending arrangements.

Moreover, the ecosystem-based approach, which is gaining momentum in the MSME lending space serves to mitigate risk and hence is posed to further enhance the credit flow into the MSME sector. Leveraging and encouraging digital financial literacy and digital lending is integral to ensuring that the flow of credit can be enjoyed by all regions and segments of the economy. As this model evolves in this economic environment, there is also a parallel need for robust regulatory guidelines for co-lending partnerships that are inclusive of digital lenders.

(The writer is CEO & Co-Founder, Indifi Technologies)

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