Banking Technology Insights - Major updates to Co-Lending - No more CLM-2

The RBI governor in his address announced major changes to co-lending arrangements. It highlights the growing importance of co-lending in today’s world. It is a win-win for all parties involved. Originators have better access to distributing loans, either through specializations done by being specialists in a sector or region, or by being in some other business, which gives them access to a niche set of customers and many times specialized data, which helps them in underwriting. Funders on the other hand, may have better access to capital, which can be deployed by being in alliance with the originators. 

An important thing to note, is that these are draft guidelines, and the final guidelines will come out after public consultations by the RBI.

💡Who can do co-lending & for what kind of loans?

• Earlier Co-Lending was allowed only for priority sector loans, that too only between banks and NBFCs.

• There was no definitive framework for example, for lending personal loans, between any two kinds of REs. Or even priority sector lending loans between two NBFCs.

• The new guidelines allow co-lending for any kind of loans between any banks and NBFCs. Although note that Small finance banks are excluded from the current guidelines again.

💡Can FLDG be given while co-lending?

• Earlier the FLDG guidelines were only defined for digital lending. These guidelines were devised such that the default guarantee was capped at 5%.

• There was no clarity on whether FLDG can be built into a co-lending structure. On the contrary, it was typically assumed that co-lending arrangements are necessarily such that the risk is shared between the two parties.

• Now it is clarified that the same 5% limit applies for co-lending arrangements, more importantly it gives legitimacy to FLDG within co-lending arrangements.

💡No more CLM2?

• Earlier there were two models for co lending, CLM 1 and CLM 2, while the CLM 1 model was allowed in the original RBI guidelines, CLM 2 guidelines were announced in 2020.

• CLM 2 guidelines announced in 2020, it allowed Banks and NBFCs to enter into arrangements, where the co-lending can happen post the disbursement, i.e., months or in some cases years after the disbursement. This allowed the entire process to be done post the actual disbursement of the loans, giving greater flexibility to the participating entities.

• CLM 1 requires the entities to give their credit decisioning in real time. The money for disbursement would be pooled in an escrow account, and all disbursements and collections would be routed through that account.

• In case where 100% money is being funded by the funder, the entire disbursement and collection would be routed through that REs account.

💡Setting interest rates for CLM loans

• Given that CLM 1 is the only allowed co-lending model now, the interest rate offered to the customer must be a blended rate between the two REs involved in co-lending.

• Specifically, the rate to be offered for CLM loans is a mixture of the rates set by the two REs. It is defined as:

CLM Rate = CLM Ratio Funder Rate + (1 - CLM Ratio) Sourcing Rate

• This puts an upper cap on the maximum rate, which can be offered during CLM. As required by the regulations, each RE would have a maximum interest rate, at which they can lend, approved by their board.

Max CLM Rate <= CLM Ratio Max Funder Rate + (1 - CLM Ratio) Max Sourcing Rate