Importance of NBFC Collaboration with the Financial Entities

With strong RBI regulations in place since the IL&FS crisis, the big NBFCs have been facing a credit crunch since 2019. However, mid-size and small size NBFCs have been doing well and ready to raise a significant amount of FDI for retail lending. India has about 9000+ active NBFCs but hardly 954 of them have a book size of over 40 crores. The remaining 8046+ NBFCs have met the regulatory cap of having a loan book of size INR 20 Million. This stat is enough to point out that most of the NBFCs need some external stimulus to grow their business.

NBFC Collaboration is one such method where existing NBFC License holders tie-up with banks/Fintech companies to source new leads and increase their funding. Collaboration in standard terms means coming together for a shared goal. Both parties may or may not assume the same percentage of NPA risk and share revenue. There is a massive number of NBFCs partnering with banks and Fintech companies to explore economical ways to boost funds and acquire clients.

In NBFC Collaborations, NBFC with exposure to a minimum of 20% of loan books and remaining part of the loan book amount shall be funded by the Bank or Fintech Company at the agreed rate of interest. NBFC Collaboration has been extremely successful by using innovative loan products and quick disbursement of loans through the latest technology and financial tools.

Collaboration Models for NBFCs with Other Entities

NBFC should search for the background of Fintech companies to understand its financial strength and its promoters profile. This becomes even more necessary in case of collaboration with a Foreign Fintech company, Necessary due diligence must be conducted before signing collaboration Agreements. Here are some of the Collaboration models which are followed by the NBFCs:

Co-Lending Model

In this model, the Fintech company supplies the information and decision-making tools for quick loan processing to the NBFC. Fintech Companies working in this collaboration perform as per the FLDG model ( First Loan Default Guarantee). It is the means to guard the lender’s interest in NBFC. Lenders invite collaterals to safeguard their advances made through Fintech Company. The model works through an Escrow Account. The FLDG could be up to 70% and the remaining 30% Loan book is financed by the NBFC from its fund. Fintech companies share 24% to 36% ROI with NBFC. Also, Fintech companies cover 100% of NPA & Expense.

Lead-Based Model

In this Model, the Fintech company sources lead and supply advanced tech-driven underwriting with risk assessment tools. NBFC usually pays commission to Fintech in the range of 1-3% of Loan Amount for leads and tool maintenance.

Co-Lending Models for NBFC and Bank Collaboration 

The Reserve Bank of India (RBI) brought out a notification related to the Co-lending model which must be incorporated between banks and NBFCs during collaboration. The said notification “ https://taxguru.in/rbi/essential-features-co-lending-model-banks-nbfcs.html ” was brought out on 05 November 2020. The objective of this notification is to extend the collaboration between banks and NBFCs in areas of lending within the priority sector of the market. Through this notification, the govt. plans to streamline the loan processing for easy disbursement to lenders in several sectors. This notification is said to be the point of co-origination for loans bought out by different banks and NBFCs to the priority sector.

Which Institutions Are Covered?

The Co-Lending model acts as a binding agreement between the parties (NBFCs and other entities) of the contract. The terms of the agreement need to be negotiated before signing the contract. The co-lending model applies to the subsequent institutions:

• Housing Finance Companies (HFCs)
• Non-Banking Financial Companies (NBFCs)
• All Scheduled Commercial Banks.

Primary Objectives of Co-lending Agreement

Some of the objectives of the Co-Lending Agreement are:

Sharing Risks and Improving Flow of Credit: Collaboration not only means improvement of lending strategies with the development of technology, but it also includes sharing of various sorts of risks/returns between the entities and NBFCs. India has a large population with a major proportion of it being marginalised and living in the rural sector. To realize the dream of making the flow of credit seamless, the Govt. has to promote initiatives to assist the agricultural sectors of society through collaboration. This can be done only if big banks collaborate with small NBFC serving this marginalised section.

Increasing Liquidity in the Market: Usually, the agricultural and small business sector finds it hard to afford loans provided by large public sector undertakings and financial institutions. Hence banks must collaborate with NBFCs to serve agricultural and small business sectors. This helps in the realisation of the government’s goal of increasing collaboration among its financial entities to increase stability. Through this scheme, different objectives and goals of banks and NBFCs are often achieved. The government has brought out several other schemes to extend collaboration between NBFCs and Fintech Companies/Banks/financial entities.

NBFC Collaboration Process with Fintechs 

• Fintech Companies and NBFCs sign Co-origination scheme Agreements
• Fintech Company will also sign an Inter-corporate deposit agreement with an intermediary Fund Manager
• NBFC signs a platform service agreement for payment of technological services provided by the Fintech company as per the agreement.
• Open Escrow Account (For Disbursement and Repayment purposes).
• An accountant or fund manager is appointed to manage the Fund and Operations of the Escrow Account.
• Both companies need to meet the necessary compliances (GST, TDS, CKYC, Credit Reporting, etc.)
• NBFC must follow the prescribed 45/90 Days norm for NPAs.
• Monthly reconciliation and CIC reporting.

Salient Features of the Co-Lending Model

The RBI brought out this Co-lending scheme with a view to increasing lending terms between Financial entities (Banks) and NBFCs. The following are the features of the Co-Lending Model:

Compliance with Law: Any sort of agreement entered by the financial institution and NBFC must suit the rules associated with Managing Risks and Code of Conduct in Outsourcing of Monetary Services. This guideline was issued within the year 2015 vide RBI notification https://taxguru.in/rbi/guidelines-managing-risks-code-conduct-outsourcing-financial-services-banks.html. Under the Co-lending model, banks aren’t allowed to enter into the other co-lending schemes, where the NBFC has direct control through a promoter group.

KYC Directions: All the agreements associated with loans must suit the RBI’s Know Your Customer (KYC) guidelines. These guidelines were issued in 2016 vide https://taxguru.in/rbi/customer-kyc-master-direction-2016.html. As per the guidelines, customer due diligence (CDD) has got to be administered and it should be consistent with the needs of the bank. Hence, this Co-lending model takes into consideration the due diligence of consumers. The banks and NBFCs need to ensure that there are effective systems to effect measures on Anti-Money Laundering and Due Diligence.

Master Agreement: The nature of the contract or agreement formed by the bank and NBFC would be a master agreement. As per this agreement, banks need to take a percentage of the share of the first loan which arises as a result of collaboration with the NBFC. The whole loan must be recorded in their books. However, the loans are subjected to rejection if they do not suit the norms of due diligence. The borrower is going to be charged a rate of interest reached as per agreement between the bank and the NBFC. The rates of interest set by the collaborating parties must be in as per with the rules of interest compliance provisions set by RBI.

Bank’s Discretion: The discretion regarding taking loans originated from NBFCs is left on the prudence and independence of the bank. Sometimes, if the loan is taken into the books, then the transaction would act as per the rules of the agreement. During this transaction, if there’s some sort of transfer of loan, then compliance must be maintained associated with the transfer. This must be following the rules which were brought out by the RBI. This should correspond to Transactions Involving Transfer of Assets through Direct Assignment of Money Flows, and the Underlying Securities issued vide notification in May 2012 whose link is as follows https://rbidocs.rbi.org.in/rdocs/notification/PDFs/FIGUSE070512.pdf. The Minimum Holding Period (MHP) wouldn’t apply to such transactions.

Minimum Holding Period (MHP): Within the Co-lending model, the MHP would only apply if the agreement has a pre-negotiated requirement for this. Therefore, the agreement must contain a clause specifying the requirement. All other conditions associated with the assignment of contracts must be met by the involved parties. Also, Any sort of assignment to a third-party lender can only be administered after securing the consent of the opposite co-lenders.

Customer Service: When handling customers, the terms of the agreement will be negotiated by NBFCs with customers. Hence, NBFCs would be the point of contact for customers for issues associated with the terms of the agreement. Additionally, the agreement must contain the roles and responsibilities of banks and NBFCs. All respective guidelines issued by the RBI associated with customer care and grievance redressal must be met by the NBFCs and Banks. These guidelines would apply to all including any agreements related to the Co-lending model. All information on the co-lending model must be disclosed to the customer. Also, every customer’s consent must be received for the agreement related to the co-lending scheme before issuing any loan under the same.

Information Sharing and Data Protection: NBFCs need to ensure that there’s a unified statement prepared for patrons/customers as per the co-lending model. This statement must be shared with the bank. Additionally, the co-lending model must adhere to the principles associated with data protection policy under the Cybersecurity Law.

Grievance Redressal: There has got to be effective systems in situ to address any sort of grievances of consumers. A committee should be formed by the collaborators as per the co-lending model. All complaints of consumers must be handled effectively in a speedy manner. The collaborators need to make sure that any complaint made with the grievance handling team must be solved within 30 days from the date of the complaint submission. If this is not resolved during the said period, the borrowers can appeal to the banking ombudsman or the NBFC ombudsman. The customer also can take their grievances to the Customer Education and Protection Cell (CEPC) set up by RBI.

Maintenance of Escrow Account: Under the Co-lending model, all banks and NBFCs need to maintain individual accounts for the administration of respective transactions. However, all reimbursements and payments made by the parties are going to be routed through an escrow account. This account is maintained by the banks. This reduces the quantity of blending of funds between the banks. The terms and conditions of the Master Agreement will have the principles associated with the formation and maintenance of the Escrow Account.

Representations and Warranties: All agreements which incorporate the terms of the co-lending agreement will have representation and warranties. These representations and warranties must be consistent with pre-negotiated agreements between the banks and NBFCs. All NBFCs under this Co-lending scheme would be responsible for the sharing of records within the books of the Bank. Also, the terms associated with the creation of security within the model need to be decided between the bank and the corresponding NBFC.

Recovery of Loans and Asset Classification: The Co-lending scheme must have respective arrangements concerning the recovery of loans from customers. Such terms associated with recovery have to be mutually agreed upon by the banks and NBFCs. All parties must meet the principles associated with asset classification. This is also applicable when parties under the co-lending model need to give information to Credit Information Companies.

Internal Audit– Any sort of loans provided under the Co-lending scheme must come under the purview of the internal/external audit between the banks and NBFC. Compliance is required for the same to maintain transparency in such transactions.

Business Continuity– The provisions concerning any co-lending agreement must not affect the regular business which is maintained by partnering banks and NBFCs with customers. Both parties must ensure that, till the last date of repayment of the loan, this scheme will be operational unless for some unavoidable reasons it has to be terminated midway.

Work Flow of NBFC-Fintechs Collaboration Model

Financial Entity 1

A Fintech Company could be a foreign company’s subsidiary with Technological and risk assessment tools necessary for the financial market. There are also many Indian Companies involved in the same business. Fintech companies source leads through their web and offline marketing campaigns. Fintech companies offer a sufficient amount of Deposits to the fund manager if they are working as per the FLDG model. Fund Managers will infuse funds in NBFC as Inter-corporate deposits. Fintech companies also render EMI collection services to the NBFC. The financial entity could also be a bank or any other financial institution using the same collaboration model.

Entity 2

This is generally a consulting firm, CA or Lawyer, that has expertise in law and finance. These firms generally do the job of managing the funds as per the instructions of the Fintech company and in return charge a service commission for the same. This is the reason why many Fintechs and NBFCs are looking to hire a ruptured legal and financial consultancy as a fund manager for their collaboration.

Entity 3

The third entity in the partnership is the NBFC, Regulated by RBI, these institutions are responsible for loan disbursement and underwriting. The Fintech company shares the inventory of borrowers curious about various loan products and NBFC disburses the loans to them after risk assessment. NBFC keep a specific amount of Revenue for Risk assessment services and loan management. Balance profit is shared with Fintech companies as per agreement.

Technological Requirements for Fintech Company

• Mobile App should be ready as per Indian customer’s requirement.
• Loan origination system, Collection system, and Loan management system must be intact to give services.
• Fintech should have their In-house Credit and underwriting software.
• Fintech should have sufficient IT Security to protect the private information of the Borrowers from misuse.
• Loan App should be ready to integrate with various APIs and should not be limited to Aadhar, PAN, or Driver license.
• A Live Borrower’s Profile Verification system should be there.
• The income verification process should be followed by the bank statement’s analysis.
• ID verification process must be employed.
• Online Verification of Employment Profile.
• Privacy norms as per law must be followed.
• The server for the app must be in India. Fintech companies will have to share a certificate in this regard.

Compliance Requirement for Fintech Companies

• Fintech Companies can only give loan through board resolution up to 60% of its paid-up capital and 100% of its free reserves and security premium (whichever is more).
• Fintech Companies must pay GST on Loan Processing fees.
• Under exception cases, approval can be granted up to 100% of its Paid-up Capital.
• Fintech Companies should meet the necessary norms in case they raise foreign funds as debt/Loan.

Compliance Requirement for NBFCs

• Online verification system for ID, PAN Card, Aadhar before processing loans.
• Borrower’s data storage capacity for five years.
• Appropriate loan processing norms must be followed.
• Reporting to Credit Information Companies regarding loan inquiry, Disbursement, Delay or default.
• Complying with norms of regulatory authorities.
• Appointment of a CA for surprise check and Audit of the Fintech company for assessment of business risk.
• Following the 45 to 90 days rule for declaring NPAs.

To Conclude…

The NBFC’s partnership with Fintechs and other financial entities like big banks could bring more stability into the existing NBFC market. there are many NBFCs that are facing low growth since 2019 and they could be revived with the technological support offered by Fintechs. Existing legal firms can also help the NBFCs and Fintechs in their collaboration and fund management. the future of the NBFC collaboration looks encouraging and let us just hope that it revives the sinking NBFCs.