What Is the Co-Lending Model in India? How Banks and NBFCs Jointly Fund Loans

A borrower in a Tier 3 city applies for a Rs 12 lakh MSME loan. The local bank branch is 40 kilometres away and does not offer business loans below Rs 50 lakh. The NBFC has the distribution reach, the borrower relationship, and the credit assessment capability, but its cost of funds is 3 percentage points higher than the bank’s, making the loan expensive. The co-lending model solves both problems simultaneously.

The co-lending model in India is an RBI-regulated arrangement where a bank and a Non-Banking Financial Company jointly originate, assess, and fund loans, combining the bank’s lower cost of capital with the NBFC’s last-mile reach and underwriting expertise. The RBI’s Co-Lending Model (CLM) Directions formalised this arrangement, setting specific requirements for risk sharing, credit assessment, and operational accountability.

This guide explains how the co-lending model works mechanically, what the 80:20 funding split means, how credit assessment responsibility is shared, and what this means for borrowers, banks, and NBFCs.

What the Co-Lending Model Is and Why the RBI Created It

The RBI introduced the co-lending framework (initially as the Co-Origination of Loans framework in 2018, revised as the Co-Lending Model in 2020 and further refined through 2024-25) to address a structural problem in Indian credit markets. Banks have cheap capital but limited last-mile reach for priority sector and small-ticket lending. NBFCs have rich underwriting expertise but expensive capital.

The co-lending model unlocks the combination: banks deploy capital through NBFCs’ distribution networks, reaching borrowers and segments they would not cost-effectively reach independently. NBFCs access lower-cost funding that allows them to price loans more competitively for borrowers.

Priority sector lending is the primary policy objective. The RBI designed the model to channel credit to agriculture, MSME, education, and affordable housing segments where priority sector lending (PSL) requirements create incentives for banks to co-lend through NBFCs with established reach into these markets.

How the Co-Lending Arrangement Works

Co-lending arrangement mechanics:

1. Master agreement: the bank and NBFC enter into a Master Co-Lending Agreement specifying the loan product types, target borrower segments, credit policy parameters, interest rate framework, and operational responsibilities.
2. NBFC originates and assesses: the NBFC identifies borrowers through its distribution network, conducts the primary credit assessment, verifies documents, and processes the loan through its LOS (Loan Origination System).
3. Dual assessment: the NBFC’s assessment is shared with the bank. The bank may apply its own credit overlay or conduct independent verification, depending on the arrangement structure.
4. Joint sanctioning: the loan is sanctioned under the joint authority of both institutions. The sanction letter identifies both the bank and the NBFC as co-lenders.
5. Disbursement: the NBFC disburses the borrower’s share from its own book first. The bank’s 80% contribution is then transferred to the NBFC within the agreed period (typically 7 days). The borrower receives the full loan amount.
6. Servicing: the NBFC typically services the loan, collecting EMIs through its existing collection infrastructure and passing the bank’s share of principal and interest to the bank on a scheduled basis.
7. NPA management: NPA classification, provisioning, and recovery are shared between the two institutions in proportion to their exposure. The credit agreement specifies the NPA management protocol.

The 80:20 Funding Split Explained.

The 80:20 funding split is the standard co-lending ratio specified in the RBI directions: the bank funds 80% of the loan and the NBFC funds 20%.

Example: A co-lent MSME loan of Rs 10 lakh:

• Bank contribution: Rs 8 lakh (80% carried on the bank’s balance sheet)
• NBFC contribution: Rs 2 lakh (20% carried on the NBFC’s balance sheet)
• Total disbursed to borrower: Rs 10 lakh

The 20% NBFC retention is a skin-in-the-game requirement. By keeping 20% of the exposure on its own book, the NBFC has a direct financial interest in loan quality and absorbs 20% of any default loss. This prevents the moral hazard of an NBFC that originates loans carelessly because the bank bears most of the risk.

The RBI allows variation in the split for specific product categories; the 80:20 is a minimum bank share requirement. Some co-lending arrangements use a 60:40 or 70:30 split depending on the product and negotiation between the parties.

Credit Assessment Responsibility in Co-Lending

Co-lending creates a dual credit assessment obligation; both the bank and the NBFC must satisfy themselves on the creditworthiness of each borrower.

NBFC’s primary assessment: the NBFC conducts the full credit assessment, income verification (bank statement analysis, GST, ITR), bureau pull, FOIR calculation, and fraud checks using its own credit policy parameters agreed under the master arrangement.

Bank’s independent credit policy: the bank cannot simply delegate credit judgment to the NBFC. The RBI requires that the bank maintain its own credit standards for co-lent loans; the NBFC’s assessment does not substitute for the bank’s own credit responsibility. In practice, this means the bank reviews the NBFC’s assessment and applies any additional credit filters specified in the master agreement.

Common credit parameters: the master agreement typically specifies minimum credit standards that apply to the combined arrangement, including minimum bureau score, maximum FOIR, minimum business vintage, and documentation requirements ensuring both institutions’ standards are reflected in the origination process.

How Loan Pricing Works Under Co-Lending

Co-lending creates a blended interest rate for the borrower, combining the bank’s lower rate and the NBFC’s higher rate in proportion to their funding contributions:

Blended Rate = (Bank Share × Bank Rate) + (NBFC Share × NBFC Rate)

Example: Bank funds 80% at 9.5% per annum; NBFC funds 20% at 16% per annum:

Blended Rate = (0.80 × 9.5%) + (0.20 × 16%) = 7.6% + 3.2% = 10.8% per annum

The borrower pays 10.8% lower than the 16% they would pay for an NBFC-only loan, but reflecting the NBFC’s higher-cost contribution. The bank receives 9.5% on its 80%. The NBFC receives 16% on its 20% plus a servicing fee from the bank for originating and managing the loan.

The servicing fee structure is a critical element of the NBFC’s economics in co-lending. For high-volume NBFCs with efficient origination, the combination of 20% book income at NBFC rates plus the bank servicing fee often produces superior economics compared to originating and holding 100% of loans on an NBFC balance sheet at a higher cost of funds.

Benefits for Borrowers, Banks, and NBFCs

• Borrower benefits: access to lower blended interest rates than a standalone NBFC loan; access to larger loan amounts than the NBFC could fund alone from its own capital; maintained NBFC service quality and relationship despite bank co-funding.
• Bank benefits: PSL-qualifying loan origination at scale through the NBFC’s established distribution without building its own rural/semi-urban presence; risk sharing with the originating NBFC (the NBFC’s 20% retention maintains alignment); access to NBFC underwriting expertise in segments where the bank has limited credit assessment capability.
• NBFC benefits: access to bank-cost capital (at 9-10% versus 13-16% from market) that improves loan pricing competitiveness; ability to originate at scale without proportionally increasing its own balance sheet funding requirement; servicing income on the bank’s 80% share providing a recurring fee revenue stream.

Key Regulatory Requirements Under RBI CLM Directions

• Board-approved policy: both the bank and the NBFC must have Board-approved co-lending policies specifying target segments, credit parameters, and risk management.
• Single loan account: the borrower must have a single loan account, not separate accounts with the bank and NBFC. The NBFC services the single account and makes back-office distributions to the bank.
• NBFC minimum 20% retention: the NBFC must retain at least 20% of each co-lent loan on its own balance sheet for the life of the loan. It cannot sell or securitise its share without specific conditions.
• Key Fact Statement: the borrower must receive a single KFS disclosing the blended interest rate, all fees from both institutions, and the co-lending structure.
• Grievance redressal: the NBFC is the primary contact for borrower grievances. The bank cannot be invisible to the borrower; both institutions must be disclosed in the loan documentation.
• Audit rights: the bank has audit rights over the NBFC’s origination process for co-lent loans. The bank cannot lend 80% without visibility into how the originating institution is assessing credit risk.

Risks in Co-Lending Arrangements

• NBFC origination quality risk: if the NBFC originates carelessly, the bank bears 80% of the loss. The bank must invest in monitoring the NBFC’s credit standards, not merely relying on the 20% NBFC retention as sufficient alignment.
• Operational complexity: managing dual books, back-office fund transfers, shared NPA classification, and combined grievance redressal creates operational burden for both parties.
• Concentration risk from one NBFC partnership: a bank with a large co-lending book concentrated in one NBFC partner faces concentrated origination risk; if the NBFC’s underwriting deteriorates, the bank’s entire co-lent book is affected.
• PSL eligibility uncertainty: co-lent loans qualify for PSL only if the underlying loan meets the current PSL eligibility criteria for the target segment. Changes in PSL definitions or eligibility thresholds can affect the PSL value of an existing co-lending portfolio.

Key Takeaways

• The co-lending model combines the bank’s lower cost of capital (80% share) with the NBFC’s distribution reach and underwriting capability (20% share and primary servicing), producing blended interest rates lower than NBFC-only loans while maintaining last-mile credit delivery.
• The 80:20 split is the minimum regulatory requirement: 80% bank-funded, 20% NBFC-retained. The NBFC retention aligns incentives and prevents moral hazard in origination.
• Blended borrower rate = (Bank Rate × 0.80) + (NBFC Rate × 0.20). The blended rate is the single rate the borrower pays; both institutions are disclosed in the loan documentation.
• Dual credit assessment is mandatory; the bank cannot delegate credit responsibility to the NBFC. Both parties apply their own credit standards within the jointly agreed parameters.

Frequently Asked Questions

Conclusion

The co-lending model is one of the most structurally elegant credit delivery mechanisms in the Indian lending ecosystem, deploying bank capital through NBFC distribution at scale without requiring either party to build what the other already has.

For NBFCs: a co-lending partnership with a bank is a capital efficiency and pricing competitiveness lever, not just a regulatory convenience. Build the operational infrastructure (LOS integration, back-office reconciliation, joint NPA monitoring) properly from the start. For banks: the NBFC partner’s origination quality is your portfolio quality. Invest in the audit and monitoring infrastructure commensurate with the volume and risk of your co-lending book.

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