Co-origination is here – will it disrupt lending?
All over the world, financial services industry is undergoing a period of intense change. The rise of FinTech, growing penetration of big tech companies and global initiatives such as open banking and PSD2 have the potential to turn this change into transformative disruption. Many of these changes are making their presence felt in India as well. The new entrants in the industry have been successful in creating a niche for themselves by offering a differentiated customer experience. They use innovative business models powered by advanced technology to offer products and services that the traditional players find difficult to match. The opening up of the ecosystem has reinforced the need for greater collaboration among the various segments of the industry. The regulators have taken notice and are actively promoting change in many areas. For example, the Reserve Bank of India (RBI) recently issued guidelines for a new initiative “Co-origination of loans by Banks and NBFCs for lending to priority sector” to further promote this industry wide collaboration.
Co-origination of loans provides a unique opportunity for Banks and NBFCs to come together to transform their approach in lending to this segment. The RBI describes the model as “sharing of risks and rewards between Banks and NBFCs”. Although the RBI circular states co-origination as an impetus to push lending to the priority sector, the model provides an excellent opportunity for banks and NBFCs to overcome their challenges and team-up with a proposition which benefits everyone, including the end-borrowers.
NBFCs have been facing difficulties in accessing funds to lend at reasonable costs, which in turn is translating into high interest rates for their borrowers. These borrowers, who are unable to access loans from banks due to reasons such as geographic location or lower credit scores, have to then turn to the unorganized financial sector, taking loans at much higher costs. With the rise in competition, stressed margins and evolving customer demands, banks have also been seeking new avenues to grow faster and tap new customer segments. Large banks, despite having big branch networks, may not be able reach certain locations, where the NBFCs have a strong presence.
With the co-origination model, NBFCs can front-end the loan origination by leveraging their strong local presence and banks can provide a significant portion of the funding for the loans. While similar models have been prevalent in the past, the unique thing here is the tripartite agreement mandated by the RBI, which will allow the borrower to have complete visibility of what percentage of their loan is coming from which institution and at what rate. Also, the credit risk would be shared by both the NBFC and the bank throughout the lifecycle of the loan. The RBI circular mandates that the NBFC will take a minimum of 20% of the credit risk by way of direct exposure, with the balance being taken by the bank. Both the parties can price their part of the contribution and a blended rate would be offered to the borrower.
While the model is a winning proposition for all stakeholders, to deliver it cost effectively demands the use of robust technology to simplify the operational challenges. Reconciling repayment schedules, bureau reporting, simultaneous credit risk assessment, hypothecation, servicing and escrow management are a few of the aspects that need to be handled within the existing workflows of the NBFC and bank but with the involvement of both parties. While one of the partner institutions would be the face of the collaboration for all customer servicing, all decisions, transactions and funds would require information flow at multiple points between both the partners.
While the institutions are still working out the operational details, there is a lot of excitement across the industry for this initiative. It may be too early to predict the long-term adoption levels, but a number of partnerships are already in place. We believe that this excitement is justified as the model provides an opportunity for competition or cooperative competition among financial institutions. This might be an instance where we see reverse disruption, i.e. large banks taking back the market share from FinTechs rather than the other way round. The financial institutions can not only optimize their lending workflows and leverage the strengths of their partners, but also benefit from the tremendous potential to provide a seamless customer experience leading to non-linear, disruptive growth.