Government Pushes Expansion of Bank-NBFC Co-Lending to Improve Credit Access for Smaller Businesses

Government Pushes Expansion of Bank-NBFC Co-Lending to Improve Credit Access for Smaller Businesses

India is stepping up its push to expand co-lending partnerships between banks and non-banking financial companies as policymakers look for ways to improve formal credit access for micro, small and medium enterprises.

The policy focus comes as a parliamentary panel examining MSME financing has highlighted the potential for wider bank-NBFC partnerships to combine the relatively low funding costs of banks with the stronger last-mile reach, specialised underwriting and customer relationships of NBFCs.

The model could be particularly relevant for smaller businesses that remain commercially viable but struggle to obtain sufficient bank financing because of limited collateral, thin credit histories or relatively small borrowing requirements.

If implemented at greater scale, co-lending could become an increasingly important bridge between India's large banking system and millions of smaller enterprises that depend on more specialised lenders.

What Is Bank-NBFC Co-Lending?

Co-lending allows a bank and an NBFC to jointly finance the same borrower under a structured arrangement.

Instead of one institution providing the entire loan, the exposure is divided between participating lenders according to their agreement and the applicable regulatory framework.

The basic logic is straightforward:

Bank provides lower-cost capital + NBFC provides origination and last-mile reach = Potentially broader and more affordable credit

The model attempts to combine the respective strengths of two different parts of India's financial system.

Banks Bring Lower Funding Costs

Banks generally have access to relatively low-cost funding because they can raise substantial deposits from customers.

That funding advantage can allow banks to offer loans at competitive interest rates.

However, traditional banking models may not always be economical for very small borrowers.

A ₹10 lakh business loan can require substantial underwriting and servicing work even though the loan generates much less absolute income than a ₹100 crore corporate facility.

This can make smaller loans less attractive under conventional branch-led models.

NBFCs Bring Distribution and Specialisation

NBFCs often operate differently.

Many specialise in particular borrower segments such as:

• Small manufacturers

• Retailers

• Transport operators

• Self-employed professionals

• Rural enterprises

• Equipment buyers

• Micro businesses

Because they focus on narrower customer segments, NBFCs can develop underwriting methods suited to borrowers that may not fit conventional bank credit models.

Co-Lending Attempts to Combine Both Advantages

The bank-NBFC partnership model seeks to solve the structural mismatch.

The NBFC can identify and evaluate customers.

The bank can contribute a substantial share of the financing.

The borrower can potentially receive credit at a lower blended cost than would otherwise be available through an NBFC alone.

The result could improve credit availability without requiring banks to independently build specialised distribution networks across every MSME segment.

MSME Credit Gap Remains a Major Challenge

India has tens of millions of micro, small and medium enterprises.

These businesses play an important role in:

• Manufacturing

• Services

• Exports

• Employment

• Local supply chains

Yet many smaller enterprises continue to face difficulty accessing formal credit.

The problem is particularly significant among micro businesses that have limited collateral or incomplete financial records.

Small Businesses Often Lack Traditional Collateral

Banks traditionally rely on several indicators when evaluating loans.

These can include:

• Audited financial statements

• Property collateral

• Credit history

• Predictable cash flow

• Established banking relationships

Many small enterprises do not possess all of these characteristics.

A profitable local manufacturer may operate from rented premises.

A small distributor may have strong sales but limited fixed assets.

A young business may simply lack a long credit history.

These conditions can make conventional lending more difficult.

Cash-Flow Underwriting Could Expand Credit

Digitalisation is gradually creating alternatives to collateral-heavy lending.

Businesses increasingly generate digital records through:

• GST filings

• Bank transactions

• UPI payments

• Digital invoices

• E-commerce sales

These records can provide lenders with greater visibility into actual business activity.

NBFCs and fintech-enabled lenders can use such information to supplement traditional credit assessment.

Co-lending partnerships can then connect those underwriting capabilities with bank capital.

Digital Public Infrastructure Strengthens the Model

India's digital financial infrastructure has made small-business lending increasingly data-driven.

Digital identity, bank-account connectivity, GST information and electronic payments can reduce some of the information gaps that historically made MSME lending expensive.

The economic opportunity is significant.

If lenders can evaluate borrowers more efficiently, the cost of underwriting smaller loans can decline.

That makes formal credit commercially viable for a larger number of businesses.

Co-Lending Can Reduce Borrowing Costs

Funding costs are one of the most important differences between banks and NBFCs.

An NBFC often raises money from:

• Banks

• Bonds

• Commercial paper

• Securitisation

These sources can be more expensive than deposits.

That cost is ultimately reflected in lending rates.

Under co-lending, direct participation by a bank can potentially reduce the blended cost of capital supporting the loan.

Some of that benefit can then reach the borrower through lower interest rates.

Lower Interest Costs Matter for Small Enterprises

Interest expenses can represent a meaningful share of profits for small businesses.

A reduction of even a few percentage points in borrowing costs can materially affect cash flow.

Lower financing costs can allow businesses to invest more in:

• Inventory

• Machinery

• Employees

• Marketing

• Expansion

This is why improving the economics of MSME credit can have broader effects on investment and employment.

Working Capital Is a Major MSME Requirement

Not every small business needs financing to build a factory.

Many simply need working capital.

A manufacturer may produce goods today but receive customer payment after 60 or 90 days.

During that period, it still needs money for:

• Raw materials

• Salaries

• Electricity

• Logistics

• Taxes

A shortage of working capital can constrain otherwise healthy businesses.

Delayed Payments Intensify Financing Pressure

Delayed payments from larger customers remain an important challenge for MSMEs.

When invoices remain unpaid for extended periods, smaller suppliers effectively finance their customers.

This can force them to borrow more heavily.

Improving loan access through co-lending therefore addresses one part of the financing problem.

Faster invoice settlement and receivables financing remain equally important.

TReDS Can Complement Co-Lending

India's Trade Receivables Discounting System provides another mechanism for improving MSME liquidity.

Through TReDS, eligible businesses can finance approved invoices before the buyer's normal payment date.

Co-lending and TReDS solve different problems.

Co-lending: Provides business loans.

TReDS: Converts receivables into earlier cash.

Used together, they can strengthen the working-capital ecosystem available to smaller enterprises.

Banks Can Reach New Borrower Segments

Co-lending is not beneficial only to NBFCs.

Banks can also gain access to customers they may not efficiently reach through their own branches.

An NBFC may already possess relationships with thousands of businesses in a particular industry or region.

Instead of duplicating that distribution network, a bank can participate in loans originated through the partner.

This can expand lending while controlling acquisition costs.

NBFCs Can Scale Without Funding Every Loan Alone

For NBFCs, capital availability can limit growth.

A lender may have strong customer demand but insufficient balance-sheet capacity to finance every eligible borrower.

Co-lending can reduce that constraint.

The NBFC can continue sourcing and servicing customers while the bank contributes part of the underlying loan capital.

This allows the NBFC's distribution network to support a larger loan portfolio.

Risk Sharing Is Central to the Model

A genuine co-lending arrangement requires both participants to retain exposure to the loans they originate together.

This matters because lending quality can deteriorate if one party originates loans without bearing meaningful credit risk.

When both institutions have capital at risk, incentives become better aligned.

The bank and NBFC both have reasons to ensure that borrowers are properly assessed.

Underwriting Standards Remain Critical

Expanding credit should not mean weakening credit discipline.

MSME lending can carry meaningful risks because smaller companies may have:

• Limited cash reserves

• Customer concentration

• Volatile revenue

• Weak collateral

• Greater sensitivity to economic downturns

Co-lending partnerships therefore need robust underwriting.

Rapid loan growth without appropriate risk controls could eventually produce higher defaults.

Technology Can Reduce Loan-Processing Costs

The economics of small-ticket lending improve significantly when processes become digital.

Technology can automate:

• Customer onboarding

• Document verification

• Credit scoring

• Bank-statement analysis

• Repayment tracking

Lower processing costs make smaller loans more economically viable.

This is particularly important because MSME lending often involves large numbers of relatively small accounts.

APIs Can Connect Banks and NBFCs

Co-lending requires significant data exchange between institutions.

Modern partnerships increasingly rely on application programming interfaces to transfer information relating to:

• Borrower applications

• Credit decisions

• Loan disbursement

• Repayments

• Delinquencies

Well-designed technology integration can make co-lending more scalable.

Without strong systems, partnerships can become operationally complex.

Customer Experience Must Remain Clear

Joint lending can create confusion if borrowers do not understand which institution is responsible for servicing the loan.

Customers need clarity regarding:

• Interest rates

• Repayment schedules

• Fees

• Customer support

• Grievance redressal

• Loan statements

Transparency becomes especially important when multiple financial institutions participate in the same credit relationship.

Regulatory Oversight Protects Borrowers

The Reserve Bank of India regulates the broader lending environment in which banks and NBFCs operate.

Co-lending structures need to comply with applicable requirements covering areas such as:

• Customer disclosure

• Credit underwriting

• Asset classification

• Provisioning

• Data handling

• Grievance mechanisms

As co-lending expands, regulatory consistency will remain important for maintaining borrower confidence.

Priority-Sector Lending Can Support Bank Participation

MSME loans can qualify within India's priority-sector lending framework when applicable conditions are satisfied.

This can make partnerships with specialised lenders strategically useful for banks seeking to reach priority borrower categories efficiently.

However, regulatory targets alone should not drive lending.

Long-term sustainability requires commercially viable borrowers and disciplined credit assessment.

Rural Businesses Could Benefit

Co-lending could have particular relevance outside major metropolitan markets.

NBFCs often have stronger distribution in smaller cities, towns and rural areas than some large banks.

This can help connect formal bank capital with businesses operating in:

• Tier-II cities

• Tier-III cities

• Industrial clusters

• Rural markets

Geographic expansion of formal credit can support more balanced economic development.

Manufacturing MSMEs Need Long-Term Capital Too

Working capital receives substantial attention, but small manufacturers also need longer-term financing.

A factory may need loans for:

• Machinery

• Automation

• Energy efficiency

• Capacity expansion

• Quality upgrades

These investments can improve productivity but require repayment over several years.

Co-lending structures could potentially support both short-term working capital and longer-duration business loans.

Exporters Face Additional Financing Needs

Small exporters need financing between production and receipt of overseas payments.

They can also face:

• Currency risk

• Shipping delays

• Customer-payment risk

Improving formal credit access can help exporters accept larger orders without creating severe cash-flow pressure.

This can become increasingly important as India seeks to expand manufacturing exports.

Women-Led Enterprises Could Gain Greater Access

Small businesses led by women can face additional financing constraints, particularly when ownership of conventional collateral is limited.

Data-based underwriting and specialised lending programmes can reduce dependence on property-backed credit.

Bank-NBFC partnerships could therefore provide another distribution channel for financing under-served entrepreneur groups.

Formal Credit Can Reduce Dependence on Informal Borrowing

Businesses unable to obtain institutional loans may rely on informal lenders.

Such financing can be:

• Expensive

• Short term

• Difficult to restructure

• Poorly documented

Expanding formal credit can reduce this dependence.

Formal loans also help businesses establish repayment histories that can improve future access to finance.

Credit History Can Create a Positive Cycle

A small company obtaining its first institutional loan begins building a formal credit record.

Successful repayment can improve its ability to borrow again.

Over time:

Formal loan → Repayment history → Better credit profile → Larger future loan

This progression can help businesses move from micro-enterprise financing toward mainstream commercial banking.

Co-Lending Can Strengthen Financial Inclusion

Financial inclusion is often associated with household banking.

But business credit is equally important.

A bank account allows an entrepreneur to participate in the financial system.

Affordable credit allows that entrepreneur to invest and expand.

Co-lending therefore represents a form of productive financial inclusion rather than simply transactional inclusion.

Competition Could Improve MSME Loan Pricing

If more banks and NBFCs enter co-lending partnerships, competition for high-quality MSME borrowers could increase.

That can potentially improve:

• Interest rates

• Processing times

• Loan structures

• Customer service

However, excessive competition can also create pressure to loosen underwriting standards.

Regulators and lenders therefore need to balance expansion with credit quality.

Banks Need Strong Partner Selection

Not every NBFC is equally suitable for co-lending.

Banks need to evaluate partners based on:

• Underwriting quality

• Portfolio performance

• Technology

• Governance

• Collection capability

• Compliance

A bank's credit exposure ultimately depends partly on the quality of loans sourced by its partner.

Partner due diligence is therefore fundamental.

NBFC Governance Becomes More Important

As NBFCs originate increasing volumes of loans ultimately funded partly by banks, their governance standards become systemically more relevant.

Banks need confidence that partner institutions maintain appropriate controls around:

• Fraud prevention

• Customer onboarding

• Collections

• Data security

• Credit decisions

Weak controls at an originating NBFC could transmit risk to multiple banking partners.

Data Sharing Must Protect Customer Privacy

Digital lending depends heavily on data.

That creates responsibilities around customer privacy and consent.

Borrower information should be collected and shared only through appropriate legal and regulatory frameworks.

Co-lending growth therefore needs to be accompanied by strong cybersecurity and data-governance systems.

Artificial Intelligence Could Change MSME Underwriting

AI-based models can analyse large volumes of transaction information and identify patterns that traditional manual underwriting may miss.

Potential inputs include:

• Cash-flow behaviour

• Invoice history

• Payment patterns

• Banking transactions

Used responsibly, such tools could help lenders assess smaller businesses more efficiently.

However, automated models also require strong governance to prevent inaccurate or unfair credit decisions.

Credit Guarantees Can Complement Co-Lending

Government-backed credit-guarantee programmes can further reduce lending risk for eligible MSMEs.

Guarantees do not replace underwriting.

Instead, they can absorb part of the loss if a qualifying borrower defaults.

Combining:

Bank capital + NBFC distribution + Digital underwriting + Credit guarantees

could create a stronger financing architecture for smaller enterprises.

The Goal Is Not Simply More Loans

The success of the policy should not be measured only by total disbursements.

A sustainable system needs to produce:

• Productive business investment

• Manageable repayment burdens

• Low fraud

• Healthy credit quality

• Repeat access to finance

Rapid credit expansion that later creates large non-performing assets would undermine the objective.

MSME Credit Quality Requires Continuous Monitoring

Small-business conditions can change quickly.

A borrower may lose a major customer or face a sudden increase in raw-material costs.

Lenders therefore need ongoing monitoring rather than relying only on the original loan application.

Digital transaction data can make this process more responsive.

Early-warning systems can identify financial stress before a borrower misses multiple payments.

Better Credit Access Can Support Employment

MSMEs are major employers.

A business obtaining financing may use the funds to:

• Buy machinery

• Increase production

• Add inventory

• Hire workers

• Open new locations

The economic effect of credit can therefore extend beyond the borrower itself.

Improving financing conditions can support broader investment and employment creation.

Co-Lending Could Support India’s Manufacturing Push

India's manufacturing ambitions depend not only on large corporations.

Major factories rely on networks of smaller suppliers.

Those suppliers need financing to invest in:

• Tooling

• Machinery

• Quality systems

• Working capital

If smaller suppliers cannot finance expansion, the entire industrial ecosystem can face bottlenecks.

MSME credit reform therefore has strategic relevance for India's manufacturing policy.

What Businesses Should Watch

The government's push for broader co-lending puts several developments in focus:

• New bank-NBFC partnerships

• MSME loan pricing

• Digital underwriting

• RBI regulatory developments

• Priority-sector lending

• Credit-guarantee usage

• TReDS adoption

• Loan disbursement growth

• MSME delinquency trends

• Rural and regional credit penetration

The key measure will be whether wider partnerships produce affordable, sustainable credit rather than simply larger loan volumes.

Outlook

Bank-NBFC co-lending has the potential to become an increasingly important component of India's MSME financing architecture.

Banks possess low-cost funding and large balance sheets.

NBFCs often possess stronger specialised distribution, borrower knowledge and underwriting capabilities in segments where traditional bank models can be less efficient.

Combining these strengths can expand formal credit while potentially reducing borrowing costs.

The next stage will depend on execution: stronger technology integration, clear customer servicing, disciplined underwriting and effective risk sharing will be essential if co-lending is to scale sustainably.

Conclusion

The government's push to expand bank-NBFC co-lending reflects a broader effort to address one of the most persistent constraints facing India's smaller businesses: access to affordable formal finance.

The model offers a practical division of strengths.

Banks can provide lower-cost capital, while NBFCs can contribute specialised underwriting and deeper reach into smaller enterprises, regional markets and underserved borrower segments.

If effectively implemented, co-lending can complement other MSME financing mechanisms such as TReDS, digital cash-flow underwriting and credit-guarantee programmes.

The opportunity is substantial, but expansion must remain tied to credit discipline.

For India's smaller businesses, the most successful outcome would not simply be more loans. It would be a financial system capable of providing the right amount of capital, at sustainable prices, when productive businesses actually need it.