Hello everyone,
Welcome to the 222nd edition of The Pattern, a weekly newsletter on the latest in finance, technology, and the economy.
In 2018, the RBI let banks and NBFCs lend together for the first time. To me, it's still one of the neatest ideas Indian lending has come up with. Banks had the cheapest money but couldn't reach the small borrower in a tier-3 town. NBFCs could reach that borrower but paid far more for their money. If they shared the loan, the bank got the borrower, the NBFC got cheaper money, and the borrower got a better rate.
Eight years on, the reach part has more than worked out: NBFCs now originate nearly half of all new-to-credit loans in India, according to a new FIDC and TransUnion CIBIL report.
So what took so long? I'll come to that in a minute, but it's telling that as late as 2024, the finance ministry had to set up an SBI-led committee, partly to figure out why banks still weren't interested. It took its time, but co-lending did eventually take off. Which is why this week feels a bit like getting your first proper salary, and finding the tax bill and a rent hike waiting for you on the same day.
So where does this go? I suspect the GST, which looks like a minor tax tweak, will end up changing who actually holds the loan. If I'm right, NBFCs that want to stay in these partnerships will need to put more of their own money into each loan over the next year, and make more of their money from the interest on that share. The ones with deep pockets won't mind much. For everyone else, it's going to be a tricky conversation.
The rules didn't help
Honestly, I can see why NBFCs held back. The RBI's 2020 framework was only for priority-sector loans. It asked NBFCs to keep at least 20% of every loan on their own books. And in one of the setups it allowed, banks could say no to a loan after running their own checks. So an NBFC might fund a loan and only later find out whether the bank was taking its share. If you ran an NBFC, would you tie up capital across a whole pipeline on that basis? I wouldn't have, and a lot of NBFCs didn't.
Then late 2023 made things a bit harder. The RBI raised the capital banks had to hold against loans to NBFCs, and banks pulled back hard on that lending. So on one side, the government was nudging banks to partner with NBFCs, and on the other, lending to NBFCs had just become more expensive for them. Mixed signals, to say the least.
Then it clicked
So what changed? First, the RBI rolled back that risk weight increase from April 2025, and banks started lending to NBFCs again, and plenty of it. Governor Sanjay Malhotra said this week that bank credit to NBFCs is now growing at about 37%. Then the rules themselves got an overhaul. The RBI's new co-lending directions, which kicked in this January, opened co-lending up to every kind of loan, brought the minimum each partner has to hold down to 10%, and made banks commit to their share upfront. That last bit fixed the very thing that had put so many NBFCs off in the first place.
Since then, more banks have started to treat co-lending as a way to reach borrowers they would never find on their own, and less as a priority sector box to tick. For the first time, it's starting to look like the idea from 2018.
And then this week happened
The finance ministry went first. It asked banks to push more digital credit to micro businesses, including working capital through credit lines on UPI and cards for micro-enterprises. Ask any bank how it plans to do that. How do you judge a small shop with no audited accounts, and how do you collect a few thousand rupees from it every month without spending most of the margin? NBFCs have built their whole business around that borrower. So, without saying it out loud, the ministry made NBFC partners more valuable.
Then the RBI raised the repo rate to 5.5%, its first hike since early 2023. We looked at why the rate cycle had turned back in #199, so the move itself didn't surprise me. What makes it awkward is that the bank across the table from an NBFC is now often its lender as well. A lot of that borrowing moves with the bank's own costs, so NBFCs will feel the hike over the next few quarters, in the very months the bank wants more from them.
The GST hits the heart of the deal. In co-lending, the loan usually carries a higher rate than the bank earns on its share, and the NBFC keeps the difference. NBFCs have always called that interest, which isn't taxed, and their industry body told the tax board as much back in 2023. The fitment committee sees it differently. It says part of that money pays for the work the NBFC does finding, assessing and collecting on the loan, and it has recommended 18% GST on that part while leaving interest exempt. The GST Council planned to take it up this week, though there's no word yet on what it decided.
So is 18% the thing to lose sleep over? I don't think so. Say an NBFC co-lends a ₹10 lakh loan. Its fee is usually a small slice of the loan, so the GST comes to around ₹900 to ₹1,800, and banks can only claim part of it back. Someone pays, but per loan it's hardly a deal-breaker. The real risk is a high minimum value for the fee or officials reopening old deals, either of which could make the bill a lot bigger.
What eight years of co-lending tells us
The pattern I see is pretty simple. Every time co-lending got easier, the cost popped up somewhere else. When the RBI formalised co-lending in 2020, it asked NBFCs to hold 20% of every loan. Then, while the government was nudging banks to partner with NBFCs, the RBI made it costlier for those same banks to lend to NBFCs directly. And now, just as co-lending has started to work, the NBFC's fee may get taxed and its borrowing has become a bit more expensive.
So where does the cost end up this time? I think it ends up in how the loan is split. A few hundred rupees a loan doesn't sound like a lot, but it adds up quickly across thousands of loans, and both sides will look for a split that makes more sense. Since the GST only applies to what the NBFC earns on the bank's share, the obvious move is for the NBFC to keep a bigger share for itself. I wouldn't be surprised if many NBFCs and banks rework their agreements along these lines over the next few quarters.
That doesn't make the NBFC any less important to the bank. Banks still need someone who knows the borrower, and with the ministry pushing them towards small businesses, they need that more than ever. But holding a bigger share of every loan takes capital, and capital has just got a little dearer. Well-funded NBFCs will manage that without much trouble. The ones that have grown mostly on fees, with very little of their own money in the loans, will find it harder, and some will have to raise capital or accept smaller returns.
I might be reading too much into this, of course. If the final rules set a low floor and banks simply absorb the cost, nothing much will change. But if I ran bank partnerships at an NBFC, I'd want to know now how much of each loan I could comfortably hold, before my bank partner asked.
Until next week,
Mayank
If you liked this edition, forward it to at least one person you think would find it useful, especially anyone who works on co-lending or bank partnerships.
All opinions expressed are my own and do not necessarily reflect the views of FinBox or its promoters.
Reading list
- RBI repo rate hike: credit growth to moderate but remain strong enough to support economy
- NBFC services to banks will attract 18% GST
- Govt asks banks to step up digital lending to micro businesses, pushes UPI credit lines
- NBFCs support 50% of new-to-credit originations
- RBI MPC meeting highlights: Repo rate hiked to 5.5%; rate cuts off the table in near term, Governor Sanjay Malhotra says
