Why Co-Lending is a Game Changer for Valuation of NBFCs

The article is authored by Mr. Kishore Lodha, Chief Financial Officer, U GRO Capital.

Co-lending, an innovative collaboration between Non-Banking Financial Companies (NBFCs) and traditional banks, has emerged as a game changer in the financial sector, presenting numerous benefits and opportunities. It has brought a revolutionary transformation to the valuation of NBFCs, reshaped their risk landscape, and ushered in a new era of growth and stability.

Evolution

The Reserve Bank of India, the central bank of India, was established in 1935 with a view of securing monetary stability, as well as creating a robust credit market. Since then, the Indian financial markets have seen multiple phases of evolution. It went from an underdeveloped banking system to the nationalization of banks, to the liberalization of the economy and democratization of credit dispensation. However, the credit gap in India is still very large and the credit-to-GDP ratio is low.

The contribution of the MSME sector to the Indian GDP is lower when compared to advanced economies — the latter see MSMEs contribute about 50% to the GDP, but in India, the contribution is still just about 30%.

The main issue that the MSME sector traditionally faced was lack of data to assess the creditworthiness of borrowers, which has now been addressed through the advent of GST as well as the demonetization process that brought many MSMEs into the formal economy.

Still, we are staring at a situation where the credit gap is high, especially for the bottom of the pyramid borrowers but at the same time, NBFCs who can efficiently do the credit dispensation to this segment suffer from the availability of capital as well as good quality debt.

Co-lending has been introduced by the RBI to address these very fundamental issues and emerged as the solution. In this, the efficiency of NBFCs is being utilized, both in underwriting the priority sector customers as well as setting up an efficient system of collections to manage the credit cost. NBFCs no longer require similar amounts of capital, nor do they require similar liquidity on their balance sheet. Moreover, since banks and NBFCs are both underwriting each individual case, transparency and trust issues disappear.

The Co-lending Advantages:

Co-lending is a strategic alliance between NBFCs and Banks wherein they jointly extend credit facilities to borrowers. This collaboration leverages the strengths of both entities, facilitating increased access to credit for borrowers and unlocking the potential for robust asset growth and diversification for NBFCs.

Speeding up Credit Dispensation to Priority Sector Borrowers 

While co-lending is designed towards credit dispensation to priority sectors, a large portion of which is being catered to by NBFCs. This is due to various reasons— the ability of NBFCs to access creditworthiness, speed of execution, and granular understanding of the need of customers.  However, NBFCs have inherent problems of capital as well as liquidity. NBFCs are regulatorily required to have higher capital compared to banks and at the same time, they have limited avenues to raise borrowing compared to banks. NBFCs don’t have avenues like CASA or liquidity from RBI.

Co-lending effectively solves these issues where NBFCs can dispense a significantly higher quantum of loans with a lower attachment of capital. They also no longer require the same amount of borrowing as a large part of it is being taken care of by banks.

This results in higher availability of credit to priority sector borrowers and at a much faster pace.

Improved Risk Management

Co-lending partnerships also lead to improved risk management practices for NBFCs as well as banks. By collaborating with banks, NBFCs can benefit from the partner bank's rigorous risk assessment processes. Banks also benefit because of NBFCs’ ability to collect from customers with the use of technology as well as them being far more agile.

Indeed, co-lending creates a better risk-reward ratio, both for NBFCs as well as banks.

Access to Lower Cost Funds

Another major factor contributing to the enhanced valuation of NBFCs through co-lending is the access to lower cost funds. Traditional banks, with their strong deposit bases and lower cost of capital, can provide funding to NBFCs at more competitive rates than those available from other sources. This synergy allows NBFCs to reduce their overall cost of funds, which, in turn, increases their profitability and efficiency metrics.

Lower Requirement of Capital and Higher ROE for NBFCs

Most of the co-lending arrangements between the banks and NBFCs are in the ratio of 80:20. This means that banks dispense 80% of the loan and 20% of the loan is dispensed by NBFCs. However, the margins for NBFCs remain the same, in some cases even better compared to balance sheet lending. Hence, by deploying 20% of the capital, NBFC can generate the same or a higher quantum of profitability resulting in higher ROAs and ROEs.

Boosting Investor Confidence

The co-lending model enhances investor confidence in NBFCs, leading to increased interest from both institutional and retail investors. The improved risk management, diversified loan portfolio, and access to lower-cost funds collectively make NBFCs more attractive investment options. As investor confidence grows, it directly impacts the valuation of the NBFC, pushing it to higher levels.

Thus, the co-lending approach has not only enhanced the valuation of NBFCs but also unlocked vast opportunities for sustained growth, benefitting borrowers, investors, and the overall economy. The future of co-lending looks promising, and it is poised to revolutionize the financial sector further in the coming years.

Moneycontrol Journalists were not involved in the creation of the article.