Once the sole preserve of large metropolitan areas and Tier-1 cities in India, credit growth is now being fuelled primarily through Tier-2 and Tier-3 cities (smaller towns) and semi-urban areas. Digital co-lending, which brings technology, distribution at the local level, and shared risk together to facilitate and improve the quality of lending, is driving the change towards increasing demand from millions of people and micro-businesses who are looking for formal credit for the very first time.
It is not merely a passing trend; it is fast becoming an essential business model for banks, NBFCs, and fintechs that aspire to develop their operations sustainably while avoiding high costs and/or unsustainable risk.
Digital Co-Lending – The Definition and the Benefits
Essentially, digital co-lending is a partnership-driven lending model. At its basic level, a bank or large NBFC will supply the regulatory and capital backing, while a fintech or smaller NBFC would manage acquiring customers, underwriting insights, and servicing the loan. In co-lending, each party will contribute funds, thus sharing the risk and returns as mutually agreed upon in advance.
When the end-to-end process of the workflow is enabled with technology, including digital onboarding, API-enabled underwriting, automated disbursement, and real-time reporting, this is referred to as digital co-lending. The co-lending software is a vital source of evidence for the participants involved since it helps all participants to stay on the same page.
In Tier 2 and 3 markets, this systematic approach to co-lending works very well. In these markets, there is a strong coupling of the fintech company’s expertise or market support for local partners with the banks, both compliant and stabilizing financially.
“Co-lending is less about splitting money and more about combining strengths — local distribution and scale play equally important roles.”
Why Tier-2 and Tier-3 offer a Promising Opportunity for Co-Lending
An estimated 60% of the MSMEs in India are located in either Tier-2 or Tier-3, and nearly all of them are not able to access the traditional bank lending channel. MSMEs in these Tier 2 and Tier 3 regions have irregular income patterns and limited credit history, and they prefer to work with tried-and-true partners to build their business. The challenges to the traditional lending model in these areas include the following:
- There are high-cost structures associated with acquiring clients
- There is a lack of extensive credit bureau data on the region
- There are manual processes associated with lending that do not scale very well.
With digital co-lending, the barriers of traditional lending are being broken with alternatives to traditional lending by creating mobile journeys, using alternative data sources, and utilizing localised distribution channels. Fintech partners are providing lenders with the ability to reliably underwrite MSME loans based on data obtained from GST, bank accounts, transactions, and cash-flow patterns without relying on credit scores.
The Role of Co-Lending Software in Scaling Efficiently
If a co-lending operation is to effectively scale, technology is essential. The ability to integrate multiple parties, share risk, reconcile products, and report to agencies will overwhelm any traditional manual process associated with co-lending. This is why robust co-lending software is important. Co-lending software applications allow lenders to:
- Automate partner onboarding and loan distribution rules,
- Provide faster Loan Aptiserment by E-KYC and E-Signature capabilities,
- Monitor and track partner repayment and delinquency rates in real-time,
- Produce Audit Compliant and Regulation Compliant MIS (Management Information Systems) and Audit reports,
- Receive real-time monitoring of partner performance through live dashboards.
Co-lending software is important to streamline or standardise processes, thereby enabling multiple district expansion without increasing the proportionate amount of people employed.
Key Trends Shaping Digital Co-lending in Today’s World
There are a number of key trends emerging that are accelerating the growth of Digital Co-lending in the Tier 2 and Tier 3 marketplaces.
- The growth of Alternative Credit Models.
FinTechs are increasingly adopting a cash flow-based underwriting model, rather than utilising asset-heavy, collateral-based approaches when underwriting small businesses and self-employed borrowers.
- Mobile-Based Lending Journeys.
With over a 70% penetration of smartphones in smaller urban areas and towns. Borrowers are becoming accustomed to digitally onboarding their loans, but need digital onboarding that is assisted, localised, and simplified.
- API-based Systems of Lending
Banks are starting to use APIs to integrate FinTech partners into their loan origination and risk management systems.
- Regulatory Environment
The clarity of co-lending Guidelines has increased trust for the banking community as well as co-lending adoption, and encouraged banks to try out different types of structured partnerships.
Best Practices to Consider When Entering These Markets
When considering entering the digital co-lending space, lenders should consider these key best practices. To optimize digital co-lending in Tier-2 and Tier-3 regions, follow these guidelines for effective implementation:
- Test smaller groups first instead of going national; this gives time for local market adjustments regarding underwriting or collections.
- Develop mobile-friendly customer “experiences” (i.e., vernacular language), which reduces chances of drop-offs from this process setting.
- Align partners’ incentives closely together; otherwise, one will reward them more for how much they did (volume) and not their quality of portfolio (credit grade).
- Monitor your partners’ activity using current data analytical reports so you can spot early warning signs about changing trendlines affecting your company’s growth rates; and
- Buy the best software available today when starting the lending program that offers you room to grow as your partnerships grow.
The Role of Technology in Risk Management
Credit risk and fraud are still concerns within the financial services industry. However, with advancements made in various technologies, you can mitigate the majority of the risks associated with these two topics. Identity verification-based solutions ensure that only the true borrower is identified during the application-review process and therefore reduce impersonation risks; control systems help detect loan-payment problems before becoming significant enough to cause a lender/borrower issue. By leveraging technology properly, lenders have appropriate visibility into cooperative loan activity, thus providing them control over loans based on the partners’ performance without micromanaging individual loans.
The Advantages of Borrowers’ Experience
Borrowers in Tier-2 and Tier-3 markets benefit through the utilization of digital co-lending technology:
- Faster access to formal credit;
- Reduced interest rate costs through shared efficiencies.
- Product designs tailored for seasonal/cyclical income levels; and
- Improved customer experience with less confusion and uncertainty.
Local relationships remain a very close part of their ability to access financial products; however, digital infrastructure provides customers with consistent, predictable results.
Conclusion
Digital co-lending in Tier 2 and Tier 3 markets has transitioned from pilot to a proven foundational business model for upcoming inclusive lenders. Competitive pressures and narrowing margins will provide advantageous opportunities for lenders to invest early in strong relationships with co-lenders and proven scalable co-lending software to benefit from this next wave of growth responsibility.
FAQs
What makes digital co-lending good for Tier 2 and Tier 3 markets?
By combining local knowledge of the market with institutional capital, digital co-lending enables lenders to deliver credit to borrowers faster while mitigating risk using technology.
Is co-lending software necessary for implementation?
Yes. The key to being able to establish a successful, sustainable, and compliant co-lending program is establishing an efficient process through the use of dedicated co-lending technology platforms and automated process management tools and dashboards for partner management, reconciliation, reporting, and allocation.
How do co-lending partners share credit risk?
Co-lending partners share credit risk proportionately within the pre-agreed risk-sharing ratios. In most cases, co-lending partner models require the loan originators to maintain “skin in the game” to help align incentive structures.
Can borrowers without credit histories qualify for a co-lending model?
Absolutely. Due to the advancements in the availability of alternative data and cash-flow-based models, lenders now have more ways to assess the creditworthiness of prospective borrowers beyond traditional bureau scores.
What is the fastest way to launch a co-lending program?
Partner with an experienced fintech provider that has strong market knowledge and an established track record; start with a pilot, and implement as many components of modular co-lending solutions as possible to reduce implementation timeframe and product-related risks.
