In co-lending, the NBFC is the only one who faces the customer. They own the customer relationship and there is no customer interaction with the bank.
The rate of a loan extended to a customer does not depend on which institution is lending to it. Its not as if person A will be entitled to a loan at X% if the loan is made by the NBFC and X-2% if made by the bank with a lower cost of capital The interest rate depends on the customer’s risk profile and will remain at X% irrespective.
When a bank does its own due diligence and decides to take on 80% of a loan underwritten by an NBFC at a lower interest rate, to the best of my knowledge they also get some first default charge protection from the NBFC i.e. the NBFC provides protection against default to the extent of 10-15% of the bank’s exposure to the loan. This is in effect default protection for 10-15% and allows banks to have the comfort to lend at a lower interest rate.
Take an example:
Loan amount INR 100
Customer interest rate 12%
Bank interest rate 10%
NBFC on-book amount of loan INR 20
Bank on-book loan amount INR 80
NBFC interest on on-book loan = INR 2.4 (12% on INR 20)
Bank interest on on-book loan = INR 8 (10% on INR 80)
NBFC Default protection guarantee = INR 8-12 (10-15% of INR 80 loan on bank books)
NBFC off-book income due to co-lending = INR 1.6 (2% on INR 80)
NBFC overall earning from loan = INR 4 (INR 2.4 on-book + INR 1.6 off-book)
NBFC ROA = 4%. At 4x D/E, this is 20% ROE
This is a great model because NBFC is incentivized to do good underwriting even under co-lending otherwise credit protection may get triggered. NBFC can increase its ROA because this model is asset light. Bank gets access to new customers and can increase its book, often they get a lot of PSL loans via co-lending for which they have to hit Govt targets. Its a win-win.
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