Finance to MFIs/Co-Lending Arrangements with NBFCs | PAPER II – PRINCIPLES & PRACTICES OF BANKING | MODULE B: FUNCTIONS OF BANKS

Finance to MFIs/Co-Lending Arrangements with NBFCs

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Background

Microfinance Institutions (MFIs) and Non-Banking Financial Companies (NBFCs) play a critical role in extending credit to underserved sectors. Banks have increasingly collaborated with these institutions to improve credit penetration through co-lending models and direct financing.

Bank Borrowings: Source of Finance for NBFCs

Banks act as a major source of funds for NBFCs by extending term loans, working capital facilities, and other structured finance instruments. This enables NBFCs to on-lend to small borrowers who may not be directly serviced by banks.

Bank Finance to NBFCs

Banks finance NBFCs based on risk assessment, credit rating, capital adequacy, asset quality, and regulatory compliance. Typically, NBFCs borrow for:

• On-lending to retail or MSME clients
• Infrastructure development
• Consumer financing

Bank Loans to NBFCs for On-Lending

Bank credit to NBFCs (other than MFIs) for on-lending is permitted for the following sectors:

• Agriculture (including small and marginal farmers)
• Micro and small enterprises (MSEs)
• Housing (including affordable housing)

Bank Loans to NBFC-MFIs

Banks are allowed to lend to NBFC-MFIs for on-lending to the microfinance sector. Such loans qualify as priority sector lending (PSL), provided end-use conditions and rate caps (as per RBI regulations) are met.

NBFC-MFI – Channelising Agent for Special Government Schemes

NBFC-MFIs are utilized as implementation channels for various government-backed schemes like:

• Pradhan Mantri Mudra Yojana (PMMY)
• Stand-Up India
• Skill development initiatives

Co-Lending by Banks and NBFCs to Priority Sector

The Co-Lending Model (CLM) allows banks and NBFCs to co-originate loans for the priority sector in a proportion (typically 80:20). Risk sharing and servicing are managed via a Master Agreement.

Example: Co-Lending Loan Distribution

Bank and NBFC agree to co-lend ₹10,00,000 to a micro-enterprise.

• Bank’s share: 80% = ₹8,00,000
• NBFC’s share: 20% = ₹2,00,000

Mathematical Illustration: Profit Sharing

Assume total interest collected = ₹1,20,000 annually.

Profit distribution based on contribution:

• Bank's profit: ₹1,20,000 × 80% = ₹96,000
• NBFC's profit: ₹1,20,000 × 20% = ₹24,000

Framework for Scale Based Regulation (SBR)

The SBR framework introduced by RBI classifies NBFCs into four layers based on their size, risk, and systemic importance:

1. Base Layer: Smaller NBFCs with minimal regulatory requirements
2. Middle Layer: Deposit-taking and larger non-deposit NBFCs
3. Upper Layer: Top 10-15 NBFCs designated as systemically important
4. Top Layer: Reserved for NBFCs posing extreme risk (currently empty)

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MCQs

1. Which of the following qualifies as priority sector lending when banks lend to NBFCs?
   • a) Loan to large corporates
   • b) Loan to NBFCs for on-lending to agriculture
   • c) Loan for trading activities
   • d) Loan for luxury housing
   Answer: b
2. What is the typical contribution ratio in co-lending arrangements between banks and NBFCs?
   • a) 90:10
   • b) 70:30
   • c) 80:20
   • d) 50:50
   Answer: c
3. Under SBR, which NBFCs fall under the Upper Layer?
   • a) All NBFCs
   • b) Cooperative banks
   • c) Systemically important NBFCs
   • d) Small MFIs
   Answer: c
4. NBFC-MFIs act as agents for which of the following schemes?
   • a) PMJDY
   • b) PMFBY
   • c) PMMY
   • d) PMGSY
   Answer: c
5. Which layer under the SBR has the least regulatory burden?
   • a) Top Layer
   • b) Base Layer
   • c) Middle Layer
   • d) Upper Layer
   Answer: b
6. Which of the following is not typically a source of finance for NBFCs from banks?
   • a) Term loans
   • b) Working capital
   • c) Deposits from public
   • d) Structured finance
   Answer: c
7. In a co-lending model, which party is responsible for loan servicing?
   • a) Bank only
   • b) NBFC only
   • c) Shared based on agreement
   • d) Third party
   Answer: c
8. Bank loans to NBFC-MFIs qualify under PSL if:
   • a) Loans are above ₹10 lakh
   • b) End-use is verified and rate caps are adhered to
   • c) Repayment is quarterly
   • d) Secured by gold
   Answer: b
9. The co-lending model was introduced to:
   • a) Replace NBFC lending
   • b) Improve loan profitability
   • c) Enhance credit flow to the priority sector
   • d) Reduce bank liabilities
   Answer: c
10. The top layer in SBR framework:
    • a) Includes all NBFCs
    • b) Currently has no entities
    • c) Is the base layer
    • d) Contains small NBFCs
    Answer: b