Small Finance Banks Approach RBI Seeking Permission to Participate in Co-Lending Arrangements

Small Finance Banks Approach RBI Seeking Permission to Participate in Co-Lending Arrangements

India's small finance banks have approached the Reserve Bank of India seeking permission to participate in co-lending arrangements, as the sector looks for additional ways to expand credit while managing funding costs, risk and priority-sector obligations.

The request comes as co-lending is gaining greater policy attention as a mechanism for combining the relatively lower funding costs of banks with the customer reach and specialised underwriting capabilities of non-banking financial companies.

Allowing small finance banks to participate more widely could expand the pool of regulated lenders available for co-lending, particularly across MSMEs, affordable housing, agriculture and other underserved borrower segments.

What Small Finance Banks Are Seeking

Small finance banks want greater regulatory flexibility to participate in co-lending structures alongside eligible lending institutions.

Under a typical co-lending arrangement, two regulated lenders jointly finance a borrower while sharing the loan exposure according to an agreed structure.

For example:

Bank + NBFC → Joint Loan → MSME Borrower

The model allows each institution to contribute different strengths to the lending process.

Why Co-Lending Matters to Small Finance Banks

Small finance banks were created with a strong financial-inclusion mandate.

Their customers frequently include:

• Micro enterprises

• Small businesses

• Farmers

• Low-income households

• Affordable-housing borrowers

• Self-employed individuals

• Borrowers in underserved regions

Many of these segments are also major target markets for NBFCs.

That creates natural potential for partnerships between the two categories of lenders.

Co-Lending Combines Different Competitive Advantages

Banks and NBFCs frequently possess different strengths.

Banks generally have access to relatively stable deposit funding.

NBFCs can possess highly specialised distribution and underwriting capabilities in specific borrower segments.

A co-lending model attempts to combine:

Bank funding + NBFC distribution + Shared underwriting + Shared credit exposure

This can potentially reduce borrowing costs while preserving access to customers that traditional bank branches may find difficult to reach.

Small Finance Banks Have Strong Last-Mile Networks

Many small finance banks evolved from microfinance institutions or organisations focused on underserved customers.

As a result, they often possess extensive experience in:

• Small-ticket lending

• Rural markets

• Informal-income assessment

• Micro-enterprise financing

• Local borrower relationships

Those capabilities can make them valuable participants in partnership-based lending models.

RBI Approval Would Expand Their Lending Options

Permission to participate more broadly in co-lending could give SFBs another mechanism for building loan portfolios.

Instead of originating every loan entirely through their own network, a small finance bank could work with specialised lending partners.

This could potentially help an SFB enter new:

Geographies, borrower categories and product segments

without building the entire distribution infrastructure independently.

MSME Credit Could Be a Major Opportunity

Micro, small and medium enterprises remain one of the most important potential beneficiaries.

Many MSMEs struggle to access formal credit because they may lack:

• Long financial histories

• Conventional collateral

• Formal documentation

• Established credit relationships

NBFCs frequently specialise in assessing such businesses using alternative information and local market knowledge.

Combining that expertise with bank funding could increase formal credit availability.

Co-Lending Could Lower Cost of Capital

Funding cost is fundamental to lending economics.

Suppose an NBFC originates loans efficiently but borrows money at a relatively high cost.

A bank may have cheaper deposits but weaker distribution in that particular customer segment.

Co-lending allows the bank to fund a substantial portion of the loan while the NBFC contributes origination and servicing capabilities.

The borrower may consequently receive financing at a more competitive rate than under an NBFC-only structure.

Small Finance Banks Have Their Own Funding Advantages

Unlike NBFCs, small finance banks can accept deposits.

That gives them access to:

• Savings accounts

• Current accounts

• Fixed deposits

• Other permitted bank funding

Deposit mobilisation can create a more diversified funding structure than wholesale borrowing alone.

Co-lending could potentially allow SFBs to deploy those funds through a wider range of origination channels.

Priority-Sector Lending Is Central to SFB Business Models

Small finance banks operate under particularly strong priority-sector lending requirements.

Their business models therefore already focus heavily on segments such as:

• Agriculture

• Micro enterprises

• Small businesses

• Affordable housing

• Weaker sections

Co-lending could help them originate qualifying loans more efficiently while maintaining regulatory compliance.

RBI Will Need to Consider Risk Allocation

Expanding co-lending requires careful regulation.

One important question is how credit risk is divided.

If two lenders jointly fund a loan, each institution needs clarity regarding:

• Exposure

• Underwriting responsibility

• Loan servicing

• Default management

• Provisioning

• Recovery

Poorly structured arrangements could create uncertainty over which institution ultimately bears losses.

Both Lenders Need Genuine Economic Exposure

A sound co-lending framework generally requires participating institutions to retain meaningful exposure to the underlying borrower.

This reduces the risk of one lender originating weak loans simply because most of the credit risk will eventually sit elsewhere.

Proper risk sharing creates stronger incentives for responsible underwriting.

Customer Protection Is Equally Important

Borrowers should clearly understand who is providing their loan.

A co-lending structure can involve:

Originator + Funding partner + Servicer

Without adequate disclosure, customers may become confused about whom to contact for repayments, grievances or restructuring.

Regulatory safeguards therefore need to ensure transparent communication.

Digital Infrastructure Makes Co-Lending Easier

Technology is helping financial institutions coordinate co-lending programmes.

Modern platforms can automate:

• Loan origination

• Eligibility assessment

• Document exchange

• Credit scoring

• Loan allocation

• Repayment tracking

• Reconciliation

This can make partnership-based lending significantly easier to scale than traditional manual arrangements.

APIs Can Connect Lending Partners

Application programming interfaces allow financial institutions to exchange information securely between systems.

A borrower applying through one lender can potentially be assessed simultaneously against another institution's lending criteria.

Approved loans can then be divided automatically according to the agreed co-lending ratio.

This infrastructure makes large-scale co-lending operationally possible.

Data Quality Will Determine Success

Technology alone cannot guarantee good lending.

Co-lending partners need accurate borrower information.

Weak data can produce weak credit decisions regardless of how sophisticated the platform appears.

Banks will therefore need strong standards covering:

• Data verification

• Credit assessment

• Fraud detection

• Income validation

• Portfolio monitoring

These controls become particularly important when origination is performed by another institution.

Small Finance Banks Could Enter New Markets Faster

Co-lending can also support geographic expansion.

A small finance bank that has limited physical presence in a particular state could potentially partner with an institution already operating there.

This provides a route into new markets without immediately establishing a large branch network.

For smaller banks, that could materially reduce expansion costs.

NBFCs Could Gain Additional Funding Partners

The benefits would not be limited to SFBs.

NBFCs would gain access to another category of banking partners.

That could diversify their funding relationships and reduce dependence on a limited group of large commercial banks.

Greater competition among funding partners could also improve co-lending economics.

More Competition Could Benefit Borrowers

If more regulated institutions participate in co-lending, borrowers could benefit from increased competition.

More lenders competing for quality borrowers can potentially produce:

• Better interest rates

• Faster approvals

• More specialised products

• Wider geographic availability

The impact could be particularly meaningful in credit segments where traditional bank penetration remains limited.

Co-Lending Could Support Financial Inclusion

India has significantly expanded access to bank accounts.

The next challenge is ensuring households and businesses can obtain appropriate formal credit.

Access to an account does not automatically mean access to affordable financing.

Co-lending could help bridge that gap by connecting bank capital with specialised last-mile lending networks.

Agriculture Could Become Another Important Segment

Agricultural lending requires specialised local knowledge.

Farm income can be seasonal and dependent on:

• Crop cycles

• Weather

• Commodity prices

• Landholding patterns

Specialised lenders can understand these dynamics better than centralised underwriting systems.

Co-lending partnerships could potentially combine such expertise with bank funding.

Affordable Housing Could Also Benefit

Affordable-housing finance is another segment where specialised NBFCs and housing-finance companies have developed substantial expertise.

Borrowers may have informal or variable incomes that require different underwriting approaches.

Small finance banks partnering with specialist lenders could potentially increase access to housing credit while sharing risk.

Co-Lending Could Help Diversify SFB Portfolios

Portfolio concentration can create risk.

A small finance bank heavily exposed to one borrower category or geography may be vulnerable if economic conditions deteriorate in that segment.

Partnerships could help SFBs gradually diversify across:

• Products

• Regions

• Industries

• Borrower profiles

Diversification can improve resilience when managed carefully.

Microfinance Concentration Has Been a Concern

Several small finance banks retain substantial exposure to microfinance because of their institutional origins.

Microfinance can deliver strong financial-inclusion benefits but can also experience periods of elevated stress.

Diversifying into secured MSME, housing and other lending categories can reduce reliance on unsecured microcredit.

Co-lending could support that transition.

Asset Quality Remains Critical

Rapid loan growth can create problems if underwriting standards weaken.

SFBs therefore need to balance growth with asset quality.

Key indicators include:

Gross NPA + Net NPA + Collection efficiency + Credit costs + Provision coverage

If co-lending expands, investors and regulators will need to monitor whether partnership-originated portfolios perform differently from directly originated loans.

Responsibility Cannot Simply Be Outsourced

A bank participating in co-lending cannot treat another institution's underwriting as a substitute for its own risk management.

Banks remain responsible for understanding the assets appearing on their balance sheets.

That means SFBs would need appropriate:

• Credit policies

• Partner due diligence

• Portfolio limits

• Monitoring systems

• Audit controls

The quality of the partner becomes part of the bank's own risk framework.

RBI Could Focus on Regulatory Arbitrage

Another important issue is regulatory arbitrage.

Banks and NBFCs operate under different regulatory structures.

Co-lending should not become a mechanism for shifting loans between institutions simply to avoid stricter rules.

Any broader framework for SFB participation would therefore need to preserve consistent prudential standards.

Partner Selection Will Become Strategically Important

Not every NBFC will be an equally suitable co-lending partner.

Small finance banks would need to assess:

• Governance

• Asset quality

• Underwriting history

• Technology

• Collection practices

• Customer complaints

• Capital strength

A poorly governed partner could create financial and reputational problems for the bank.

Co-Lending Economics Must Work for Both Institutions

The partnership needs to generate adequate returns for both parties.

The bank contributes capital.

The originating institution may contribute:

• Distribution

• Underwriting

• Servicing

• Collections

The interest income and fees therefore need to be divided in a way that reflects the economic contribution and risk of each participant.

Scale Could Improve Operating Efficiency

Once technology integration is complete, successful co-lending partnerships can process large loan volumes with relatively low incremental operating costs.

That creates potential economies of scale.

The initial investment in APIs, risk systems and reconciliation may be significant.

But once established, the same infrastructure can support thousands of loans.

Co-Lending Could Strengthen Formalisation

Greater availability of institutional credit can encourage small businesses to maintain better financial records.

Formal borrowers increasingly need:

• Bank statements

• GST records

• Digital payment histories

• Financial statements

This can gradually bring more economic activity into documented financial channels.

Formalisation can then improve future access to credit.

Digital Public Infrastructure Can Support Underwriting

India's digital financial ecosystem provides lenders with increasingly sophisticated tools for assessing borrowers.

Digital payments, account aggregation and other consent-based data systems can help lenders understand financial behaviour more accurately.

Combined with co-lending, this infrastructure could make small-ticket business lending more scalable.

Small Finance Banks Could Become Important MSME Lenders

SFBs occupy an unusual position in India's financial system.

They combine:

Banking licences + Deposit access + Financial-inclusion mandate + Last-mile expertise

That makes MSME lending a natural area for expansion.

Broader co-lending permission could accelerate this evolution.

Larger Banks Could Face More Competition

If SFBs gain greater freedom to participate in co-lending, large commercial banks may face more competition for partnerships with high-quality NBFCs.

NBFCs would have a broader set of potential funding partners.

That could strengthen their negotiating position and encourage innovation in partnership structures.

Fintech Platforms Could Also Benefit

Co-lending expansion can create opportunities for financial-technology providers supplying infrastructure to lenders.

Potential services include:

• Loan-management systems

• API integration

• Risk analytics

• Fraud detection

• Collections technology

• Reconciliation

The regulatory expansion of co-lending could therefore create a wider technology ecosystem around partnership-based credit.

Regulation Will Determine the Final Opportunity

The sector's request does not itself change the regulatory framework.

The RBI's response will determine whether and under what conditions small finance banks can expand their participation.

Possible regulatory considerations could include:

• Eligible partners

• Exposure limits

• Risk-sharing requirements

• Customer disclosures

• Asset classification

• Provisioning

• Data-sharing standards

• Outsourcing controls

The details would ultimately determine the commercial attractiveness of the model.

What Small Finance Bank Investors Should Watch

Investors should monitor whether RBI provides formal regulatory clarification and how individual SFBs respond.

Important indicators would include:

• Co-lending portfolio growth

• Cost of funds

• Net interest margins

• Asset quality

• MSME exposure

• Partner concentration

• Credit costs

A successful co-lending strategy should ideally expand lending without materially weakening underwriting quality.

Outlook

Small finance banks' request to participate more widely in co-lending reflects the continuing evolution of India's credit market.

The model offers a potentially attractive combination of bank funding, specialised origination and shared credit risk, particularly for MSMEs and other priority-sector borrowers.

For SFBs, broader participation could provide a route to diversify portfolios, reach new customers and deploy deposits through additional lending channels.

However, the benefits will depend heavily on the regulatory framework established by the RBI and the quality of individual lending partnerships.

Conclusion

The push by small finance banks for access to co-lending arrangements could become an important development in India's financial-inclusion strategy.

SFBs already possess strong capabilities in underserved markets, while NBFCs and other specialist lenders often have deep expertise in specific borrower categories.

Combining these strengths could increase the flow of formal credit to MSMEs, affordable-housing customers, agricultural borrowers and other priority-sector segments.

The opportunity is substantial, but so are the risk-management requirements.

Co-lending works effectively only when underwriting responsibility, customer protection, data sharing, servicing and credit exposure are clearly defined.

The RBI's eventual response will therefore determine whether co-lending becomes a meaningful new growth channel for India's small finance banks.