- By Shachindra Nath
Funding challenges have become quite large for the non-banking financial company (NBFC), especially for the small and mid-sized ones that are staring at constrained growth thanks to limited exposure to the debt market, controlled access to bank loans as well as rising interest rates. Similarly, lending more precisely priority sector lending has also become quite an arduous one for the banks as well. However, co-origination of loans – on which Reserve Bank of India (RBI) has issued guidelines recently – could change the scenario altogether.
As per the co-origination mechanism, which is symbiotic in nature, banks and NBFCs come together to jointly contribute to credit at the facility level. Both banks and NBFCs share risks and rewards however, the origination rests with the smaller NBFC. The co-origination model combines the strengths of two sectors –the financial wherewithal of the banks and intricate ground-zero understanding of the NBFCs.
We have recently seen, multiple specialized NBFCs emerging across the market to tackle the large credit availability in India. However, these firms are relatively small in size and operation and do not have the capital to support a large asset under management (AUM). These NBFCs due to their size and vintage do not have a great credit rating and therefore, their ability to lever at a reasonable cost is very low. This puts pressure on the promoters to raise equity capital at regular intervals to support the growth of the firm. A lower leverage also results in lower return on equity (ROE), thus impacting the valuation at which such firms can raise capital.
Having said that, their commitment to serve the under-served can’t be ignored. There shouldn’t be any doubt on the ability of such firms to originate and underwrite hitherto underpenetrated segments. These companies banking on their specializations have developed unique and effective ways of underwriting segments leveraging psychometric tests, deep knowledge of clusters, among others.
Co-origination helps these firms to leverage the balance sheet of larger banks or NBFCs to not only improve their ROEs but also provide a better experience and rates to their customer. From the perspective of the banks, this is an extremely opex-efficient way to originate loans. Because of co-origination, banks do not have to set up a massive branch infrastructure to lend. Moreover, what works in the bank’s favour in this case is that they are able to leverage the specialized knowledge of these firms to create a better loan book – which the banks were unable to develop internally due to the sheer number of segments they cater to. On the other hand, NBFCs will be able to grow their AUM sans capital constraints.
The concept of co-origination will also be able to help banks meet the priority sector lending (PSL) criteria. This will motivate banks to alter their perspective towards PSL from statutory obligation to new business opportunities. Priority sectors can aspire for sustainable growth because of the introduction of co-origination model.
The implementation of co-creation model will create a win-win scenario for all stakeholders – the large financiers, the specialized lending companies and the customer.
So, to realize the effectiveness of co-origination in solving the lending woes, RBI has recently published a co-origination circular which lays out the framework for banks and NBFCs to co-originate PSL books. However, banks and NBFCs have to come together to prepare the ground for a successful implementation of co-origination model. And to make the collaboration work, banks need to come out of the traditional rating model and develop sensitive outlook towards the requirements of the SMEs. That’s how financial inclusion in the true sense of the term can be achieved.
Banks in India already work closely with NBFCs when it comes to securitization and on-ward lending – Banks exposure to NBFC debt stands at INR 5,754 Bn as at February, 2019 while securitization volumes were north of INR 730 Bn for the financial year. Co-origination is the next logical step.
In India, we have witnessed multiple announcements of such collaboration-led initiatives before. However, it will take some time for us to emulate global markets where specialized firms like OnDeck – originate and underwrite credit for global giants like JPMorgan.