RBI Notification

RBI introduces the Co-Lending Model between Banks & NBFCs

Recently, the Reserve Bank of India has proposed the Co-Lending Model scheme, where in the commercial banks can now provide credit in collaboration with the NBFCs. This scheme is for providing easy loans to the commercial borrowers of the priority sector. As per this scheme, the loans shall be provided to the businessmen on the basis of an agreement to be signed in advance.

Background of the Co-Lending Model scheme

As we all know that the during the period of lockdown due to COVID-19, the Government has given certain reliefs to the borrowers by way of extending the moratorium on loans. The long period of inactivity during lockdown and the substantial reliefs that Government had to give to the borrowers, collectively had deepened the NPA crisis in Indian banking system. As a result, the commercial banks are facing difficultly in providing new loans due to the fall in their asset value.

In order to mitigate the crisis of the banks, the RBI has introduced the Co-Lending Model between Banks and NBFC– Non-Deposit taking – Systemically Important (NBFC-ND-SIs). The key objective behind the CLM scheme is to enable the financial institutions to provide easy credit to the borrowers of the priority sector.

Firstly, we must understand the meaning of priority sector and which all business activities are included in it.

Priority Sector

RBI considers some crucial sectors of the economy as Priority Sectors. These are the sectors of the economy where timely and sufficient credit may not reach easily. The Priority Sector includes the categories as follows:

• Agriculture
• Micro, Small and Medium Enterprises (MSMEs)
• Export Credit
• Education
• Housing
• Social Infrastructure
• Renewable Energy
• Start-ups
• Miscellaneous

We shall now understand the guidelines regarding this scheme in details.

Broad guidelines regarding the Co-Lending

The Central Bank has given broad guidelines regarding the Co-Lending Model vide its notification dated 5^th November 2020. We will discuss those guidelines in detail.

Asset Creation:

RBI direct all the scheduled commercial banks, except the Rural Banks and Small-Finance Banks, to co-work with NBFC-ND-SIs for co-lending and giving loans to the priority sector. The system must involve the combined contribution of credit by both the lenders.

This will also imply sharing of the risks and profits among the lending bank and the lending NBFC. This is for the fulfilment of the joint business objectives, in accordance with the mutually signed agreement between the 2 lenders. Hence, we can see that both the lenders shall be required work like a joint venture.

Co-lending with housing finance companies:

The RBI shall also permit banks to co-lend with the home loan entities having NBFC registration, especially the Housing Finance Companies (HFCs) on basis of the prior agreement. The co-lending banks will then be allowed to take their share of individual loans subsequently in their book of accounts. However, the NBFCs in such case must show a minimum of 20% share of the individual loan in their books.

Board Resolution for CLM:

The co-lending banks & NBFCs shall be required to appoint a Board for formulate and approve policies to enter into the CLM. The board-approved policies have to be uploaded on their websites. On the basis of these Board approved policies; a Master Agreement shall be signed by the 2 co-lending institutions. This Master Agreement shall inter-alia include the following:

• Terms& conditions of arrangement,
• Criteria for selection of co-lending institutions,
• Loan Product lines and their areas of operation, and
• The provisions for delegation of the responsibilities as well as customer interface and protection policy.

Rejection of certain loans

As per the Master Agreement, the banks shall have 2 options: whether to take their share of the individual loans co-originated with the NBFCs in their books strictly according to the terms of the agreement; or to retain their discretion of rejecting some loans.

However, this will be permissible only upon their due diligence by a 3^rd party, which shall be done much prior to entering in their book of accounts.

Banks as priority sector units

The banks themselves can also claim the status of a priority sector with respect to their share of credit, while being entered into the CLM. However, in such situation, the banks shall be subject to certain specific conditions.

Role of the foreign banks

The RBI has laid down separate criteria for the foreign banks in CLM. Foreign banks (incl. WOS) having branches below 20 shall not be eligible for the CLM.

Salient features of the CLM

Now we shall discuss the key regulations of entering into the CLM. This shall entail the following aspects:

• Customer grievance redressal
• Operational Aspects
• Scope of CLM

Customer grievance redressal

For effective grievance redressal, the following directives have been laid down:

• The NBFCs shall be the front face for the borrowers in loan agreement. These NBFCs shall only enter into a loan agreement with the borrower. Agreement shall clearly mention the key highlights of the loan along with the functions and responsibilities of NBFCs &banks.
• All the key details of the loan arrangement shall be disclosed to the borrowers directly. Their consent shall be taken clearly before entering into agreement.
• The ultimate borrowers shall be charged an interest rate that will be all-inclusive as per the agreement by both the lenders in proportion of their ratios as per the guidelines applicable to both.
• The extant guidelines with respect to the customer service as well as the fair practices code and the obligations imposed on the lenders therein shall be applicable mutatis mutandis, to the loans offered under the agreement.
• The NBFC is supposed to obtain a clear and explicit statement from the borrowers, after properly sharing their details with the bank.

Grievance redressal mechanism:

With respect to the grievance redressal mechanism, an appropriate methodology must be there as per which the co-lenders can resolve the complaints of the borrowers.

• The grievance must be addressed within 30 days by the NBFC.
• On failure to resolve the complaint within the time frame the borrower is empowered to do escalation with the: –
  • Concerned Banking Ombudsman,
  • The Ombudsman for NBFCs, or
  • The Customer Education and Protection Cell (CEPC) of RBI.

Operational Aspects

The operational aspects of the co-lenders have been clearly spelled out by the RBI^[1] as below:

Separate accounts for transactions:

• The co-lenders, i.e., banks and NBFCs have to maintain each borrower’s separate account for accounting their respective credit exposures.
• For the transactions related to the CLM agreement between the banks& NBFCs e.g., disbursement and repayments, a separate escrow account has to be opened. All such transactions shall be channelized through this account. This is to avoid jumbling and miscalculation of transactions.
• The method for accounting shall be followed by the co-lenders strictly as specified in the Master Agreement.

Conditions for sharing of loan:

• With respect to the loan share taken into its books by the bank, the Master Agreement shall specify necessary clear clauses mentioning representations &warranties to which the originating NBFC shall be held liable.
• The co-lenders are required to set up a framework for the loan monitoring & recovery, as per the agreement.
• The co-lenders have to arrange for creation of collateral security and levy interest as per the mutually agreeable terms.

Asset classification:

Both lenders must adhere to the regulatory guidelines for asset classification and requirements for creating provisions, and report the same to the Credit Information Companies.

Central Bank statutory audit

The loans given as per the CLM shall come under the purview of internal or statutory audit of the RBI. Both the lenders shall be subject to audit to ensure proper compliance to their respective internal guidelines, terms of the agreement and the extant regulatory requirements.

Transferring of loan:

Transfer of a loan can be done by a co-lender to any3rd party only on the consent of the other co-lender.

In such case, both the co-lenders shall execute a “business continuity plan” that will assure an uninterrupted service to the customer still his repayment of loan under the CLM agreement. Such a case implies termination of the co-lending arrangement among the co-lenders.

Conclusion

As discussed earlier, bank has the option to mandatorily take their loan share originated by the NBFC into its book of accounts, or to reject certain loans subject to proper due diligence. In this regard,

• If the Agreement entails a prior, irrevocable commitment on the part of the bank to take into its books its share of the individual loans as originated by the NBFC, the arrangement must comply with the extant guidelines on Managing Risks and Code of Conduct in Outsourcing of Financial Services by Banks.
• The co-lenders shall have to put in place suitable mechanisms for ex-ante due diligence by the bank.
• The banks have to comply with the Master Directions – Know Your Customer (KYC) Direction, 2016. This allows the co-lenders to carry on with the customer due diligence done by external party, subject to certain conditions specified.
• If the banks take their loan share originated by the NBFC, the taking over bank shall ensure compliance with all the requirements in terms of Guidelines on Transactions Involving Transfer of Assets through Direct Assignment of Cash Flows and the Underlying Securities. Here, there’s an exception of Minimum Holding Period (MHP) which shall not be applicable in such transactions undertaken in terms of this CLM.
• Very importantly, Banks shall not be allowed to enter into co-lending arrangement with an NBFC belonging to the promoter Group

Read our article:Difference between Banks and NBFCs