The Co-Lending Model (CLM) has emerged as one of the most significant developments in India's lending ecosystem, particularly in the areas of Priority Sector Lending (PSL), financial inclusion, MSME financing, affordable housing, agriculture financing, and digital lending. The model was introduced by the Reserve Bank of India (RBI) to improve the flow of credit to underserved sectors by leveraging the strengths of both banks and Non-Banking Financial Companies (NBFCs). While banks generally possess access to low-cost funds and strong balance sheets, NBFCs often have deeper market penetration, localized borrower understanding, technology-driven origination capabilities, and better last-mile connectivity.

The objective of the Co-Lending Model is to combine these strengths and facilitate greater credit availability to sectors that traditionally face difficulties in obtaining institutional finance. Over time, the co-lending context has evolved from a limited Priority Sector Lending mechanism into a broader regulatory structure covering multiple categories of lending arrangements. The RBI has significantly expanded the scope of co-lending through the Co-Lending Arrangements Directions, 2025, which are scheduled to become effective from January 1, 2026.

In this article, CA Manish Mishra talks about Co-Lending Model in India: RBI Guidelines and Practical Issues.

Evolution of the Co-Lending Context

The concept of co-lending was initially introduced by the RBI in 2018 through a co-origination model between banks and NBFCs for lending to the priority sector. The context was designed to improve credit penetration in rural and semi-urban markets where NBFCs had stronger operational presence. Subsequently, the RBI revised the framework in 2020 and formally introduced the Co-Lending Model (CLM), allowing banks and NBFCs to jointly lend to borrowers under structured arrangements.

The growing adoption of co-lending arrangements, increasing use of fintech platforms, digital lending partnerships, and evolving credit distribution models led the RBI to revisit the framework. In 2025, the RBI released and finalized revised Co-Lending Arrangements Directions creating a unified context applicable across regulated entities. The revised framework substantially expanded the regulatory scope beyond Priority Sector Lending.

Legal Governing Co-Lending

The legal foundation of co-lending arrangements in India is derived from multiple regulatory sources. These include the Reserve Bank of India Act, 1934, the Banking Regulation Act, 1949, various RBI Master Directions applicable to banks and NBFCs, Digital Lending Directions, Transfer of Loan Exposure (TLE) Directions, outsourcing guidelines, and the RBI Co-Lending Arrangements Directions, 2025.

The RBI regulates co-lending arrangements under its supervisory authority over regulated entities such as banks, NBFCs, Housing Finance Companies (HFCs), and certain financial institutions. The regulatory framework aims to ensure proper risk-sharing, transparency, consumer protection, operational accountability, and prudential supervision. The new Directions attempt to create a harmonized legal structure for co-lending arrangements across the financial sector.

Meaning of Co-Lending

Co-lending refers to a lending arrangement in which two regulated entities jointly provide credit to a borrower under a pre-agreed structure. Both lenders participate in funding the loan, share the risks and rewards associated with the credit exposure, and remain responsible for their respective portions of the lending arrangement.

Unlike traditional assignment or securitization transactions, co-lending involves joint participation from the loan origination stage itself. Under the revised RBI, lenders are expected to jointly originate and fund loans rather than follow selective post-disbursement transfer models. The intention is to ensure genuine risk-sharing and improve transparency in the lending process.

Objectives of the Co-Lending Model

The primary objective of co-lending is to improve access to institutional credit. India continues to face significant credit gaps in agriculture, MSMEs, affordable housing, microfinance, and other underserved sectors. Banks often face operational challenges in reaching remote borrowers, whereas NBFCs have stronger local presence and borrower relationships.

The co-lending context allows banks to utilize NBFC distribution capabilities while enabling NBFCs to access lower-cost funding. The arrangement helps improve credit flow, reduce borrowing costs, expand financial inclusion, and increase lending efficiency. The model also supports government initiatives aimed at strengthening formal credit access across the country.

Eligible Participants Under RBI Guidelines

The earlier co-lending context was largely restricted to arrangements between banks and NBFCs. However, the RBI's revised Co-Lending Arrangements Directions, 2025 have expanded the framework significantly.

Under the revised context, co-lending arrangements may now be entered into by eligible regulated entities including commercial banks, NBFCs, Housing Finance Companies, and certain All India Financial Institutions. Institutions such as NABARD, SIDBI, and NaBFID may also participate under specific circumstances. This expansion reflects the RBI's intention to broaden institutional participation in joint lending activities.

Structure of Co-Lending Arrangements

Co-lending arrangements operate through a contractual framework known as a Co-Lending Agreement (CLA). This agreement defines the rights, obligations, risk-sharing mechanisms, funding proportions, servicing responsibilities, borrower disclosures, and governance standards applicable to the participating entities.

The revised RBI emphasizes predetermined sharing ratios and requires both lenders to participate from the beginning of the lending transaction. The structure must clearly define loan origination procedures, credit underwriting standards, repayment mechanisms, default management protocols, and borrower grievance handling systems. Proper contractual documentation is essential because regulatory compliance obligations arise directly from the terms of the arrangement.

Risk Sharing Requirements

One of the most important aspects of the revised co-lending framework is the emphasis on genuine risk-sharing. RBI has introduced mandatory exposure retention requirements to ensure that each participating lender maintains a financial stake in the underlying loan portfolio.

Under the final Co-Lending Arrangements Directions, each lender is generally required to retain at least 10% of the individual loan exposure on its books. This requirement aims to prevent purely synthetic arrangements where one lender assumes little or no credit risk while benefiting from regulatory advantages. The retention requirement strengthens accountability and aligns incentives between participating entities.

Compliance Requirements Under Co-Lending

Regulated entities participating in co-lending arrangements must establish detailed compliance. Compliance obligations extend beyond loan origination and include governance controls, internal policies, borrower disclosures, reporting systems, data-sharing protocols, and regulatory monitoring mechanisms.

Institutions must maintain proper documentation demonstrating compliance with RBI guidelines. Internal audits, compliance reviews, and supervisory inspections frequently assess whether co-lending arrangements satisfy regulatory expectations. The RBI expects participating entities to maintain strong operational controls and clearly documented procedures governing all aspects of co-lending operations.

Borrower Protection and Disclosure Requirements

The RBI has placed significant emphasis on borrower protection under the revised. Borrowers must be informed regarding the identities of participating lenders, allocation of responsibilities, grievance redressal mechanisms, interest computation methodologies, and repayment structures.

The co-lending agreement should not create confusion regarding borrower obligations. The revised Directions require greater transparency in customer communication and aim to ensure that borrowers understand the nature of joint lending arrangements. Consumer protection has become particularly important due to the increasing integration of digital lending platforms within co-lending structures.

Co-Lending and Digital Lending Regulations

The rapid growth of digital lending has significantly influenced the co-lending ecosystem. Many co-lending transactions are now originated through digital platforms operated by NBFCs, fintech companies, or technology service providers.

The RBI's Digital Lending Directions impose additional compliance requirements relating to borrower consent, data privacy, disclosure standards, outsourcing arrangements, grievance redressal, and third-party service providers. Co-lending arrangements involving digital channels must simultaneously comply with both co-lending regulations and digital lending regulations. This has increased compliance complexity for regulated entities.

Asset Classification and NPA Issues

One of the major regulatory changes introduced under the revised relates to borrower-level asset classification. Under the final Directions, if one participating lender classifies a borrower account as a Non-Performing Asset (NPA), the corresponding exposure of the co-lending partner may also require similar treatment.

This borrower-level classification mechanism seeks to prevent inconsistent reporting and regulatory arbitrage. However, it also creates operational challenges because participating lenders must maintain synchronized monitoring systems and share credit performance information efficiently. The change significantly increases coordination requirements among lenders.

Default Loss Guarantee (DLG) and Risk Mitigation

Default Loss Guarantee arrangements have become common in digital lending and co-lending structures. Under DLG arrangements, one party agrees to absorb a specified portion of losses arising from borrower defaults.

The RBI has imposed limitations on such guarantees to prevent excessive risk transfer. Under the revised framework, DLG structures are generally aligned with Digital Lending Directions and are subject to regulatory caps. Recent regulatory discussions have focused on limiting DLG exposure to a specified percentage of outstanding loans to preserve genuine risk-sharing principles.

Practical Issues in Co-Lending Arrangements

Despite its advantages, the co-lending model faces several practical challenges. One of the most common issues relates to operational integration between participating lenders. Banks and NBFCs often use different technology systems, underwriting methodologies, risk assessment models, and servicing platforms.

Another major challenge involves allocation of responsibilities relating to customer onboarding, KYC verification, documentation management, collection activities, and dispute resolution. Regulatory compliance becomes complicated when multiple entities are involved in servicing the same borrower relationship. Differences in organizational culture, risk appetite, credit policies, and governance standards may also create operational friction. In practice, achieving seamless coordination between participating entities remains one of the biggest challenges within co-lending arrangements.

Industry Concerns Regarding Revised RBI Context

The revised RBI framework has generated extensive discussion within the financial industry. Industry bodies have expressed concerns regarding mandatory joint origination requirements, retention obligations, operational costs, and the elimination of certain discretionary lending structures.

Several stakeholders have argued that stricter regulatory requirements may increase compliance burdens and reduce flexibility in credit delivery models. Industry representatives have also highlighted concerns regarding implementation costs, technology integration requirements, and potential impact on financial inclusion objectives.

Recent RBI Updates and Regulatory Developments

The most significant recent development is the issuance of the RBI Co-Lending Arrangements Directions, 2025. These Directions expand co-lending beyond Priority Sector Lending, introduce mandatory risk-sharing requirements, strengthen borrower protection norms, require enhanced disclosures, and establish uniform asset classification standards.

Also introduces stricter governance requirements, escrow-based cash flow mechanisms, single KYC processes, enhanced reporting obligations, and tighter controls over Default Loss Guarantees. The new Directions are expected to substantially reshape the co-lending site from January 2026 onwards.

Conclusion

The Co-Lending Model has become an important component of India's evolving credit ecosystem by combining the strengths of banks, NBFCs, and other regulated entities. The context supports financial inclusion, improves credit access, reduces funding costs, and enhances lending efficiency across underserved sectors.

The RBI's revised Co-Lending Arrangements Directions, 2025 represent a major regulatory shift toward stronger governance, genuine risk-sharing, borrower protection, and enhanced transparency. While the new framework introduces significant compliance obligations and operational challenges, it also provides greater regulatory clarity and institutional stability. As co-lending continues to expand across priority sector and non-priority sector lending, regulated entities will need to strengthen compliance frameworks, technology integration, and governance mechanisms to successfully operate within the evolving regulatory environment.

Frequently Asked Questions (FAQs)

Q1. What is the Co-Lending Model (CLM)?

Ans. The Co-Lending Model (CLM) is a lending arrangement in which two regulated entities, such as a bank and an NBFC, jointly provide loans to borrowers under a pre-agreed framework. Both lenders participate in funding the loan and share the risks and returns associated with the credit exposure.

Q2. Why did the RBI introduce the Co-Lending Model?

Ans. The RBI introduced the Co-Lending Model to improve credit flow to underserved sectors such as agriculture, MSMEs, affordable housing, and microfinance. The framework combines the low-cost funding capabilities of banks with the strong customer reach and local presence of NBFCs.

Q3. Which entities can participate in co-lending arrangements?

Ans. Under the revised RBI framework, co-lending arrangements may be entered into by regulated entities such as Scheduled Commercial Banks, Non-Banking Financial Companies (NBFCs), Housing Finance Companies (HFCs), Small Finance Banks, and certain All India Financial Institutions, subject to RBI guidelines.

Q4. Is co-lending different from loan assignment or securitization?

Ans. Yes. In co-lending, both lenders participate from the loan origination stage and jointly fund the borrower. In loan assignment or securitization, the loan is typically transferred after origination. Co-lending involves ongoing risk sharing between the participating lenders.

Q5. What is the purpose of co-lending in Priority Sector Lending (PSL)?

Ans. Co-lending helps banks achieve Priority Sector Lending targets by partnering with NBFCs that have expertise in serving sectors such as agriculture, MSMEs, affordable housing, and rural borrowers. It increases credit penetration while maintaining regulatory compliance.

Q6. What is a Co-Lending Agreement (CLA)?

Ans. A Co-Lending Agreement is a contractual document executed between participating lenders. It defines funding proportions, risk-sharing arrangements, servicing responsibilities, borrower disclosures, collection procedures, default management mechanisms, and compliance obligations.

Q7. How is risk shared under the Co-Lending Model?

Ans. Under RBI guidelines, both lenders must retain a portion of the loan exposure on their books. The risk-sharing ratio is agreed upon in advance and documented in the Co-Lending Agreement. The revised RBI framework also prescribes minimum retention requirements to ensure genuine participation by both lenders.

Q8. Who performs customer onboarding and KYC verification?

Ans. The responsibility for customer onboarding and KYC verification is generally determined under the Co-Lending Agreement. However, both lenders remain responsible for ensuring compliance with RBI's Know Your Customer (KYC) and Anti-Money Laundering (AML) requirements.

Q9. How are repayments handled in co-lending arrangements?

Ans. Repayment collections are generally managed through designated accounts and servicing arrangements agreed between the lenders. The collected amounts are distributed according to the agreed funding ratio and servicing structure mentioned in the Co-Lending Agreement.

Q10. Can co-lending be conducted through digital lending platforms?

Ans. Yes. Many co-lending arrangements are originated through digital lending platforms. However, such arrangements must comply with RBI Digital Lending Guidelines, borrower consent requirements, data privacy obligations, disclosure standards, and grievance redressal requirements.