Finance to MFIs / Co-Lending Arrangements with NBFCs
Principles & Practices of Banking | Module B · Chapter 38
Chapter 37 covered Agricultural Finance under Priority Sector Lending. This chapter expands the credit ecosystem — covering how banks fund NBFCs and MFIs, the regulatory boundaries for such funding, the Co-Lending Model (CLM) for priority sector delivery, and RBI's Scale Based Regulation (SBR) framework for NBFCs.
📌 Why This Chapter Matters in JAIIB
Expect 4–6 questions from this chapter. Key focus areas: NBFC exposure caps (single NBFC: 20% Tier I; group: 25% Tier I; gold loan NBFC: 7.5% Tier I+II, extendable to 12.5% for infrastructure); NBFC-MFI qualifying assets ≥ 85% of net assets; first cycle loan ≤ ₹75,000; subsequent ≤ ₹1,25,000; margin cap(10% for large MFIs >₹100 cr portfolio; 12% for others); CLM — NBFC must retain ≥ 20% share; all CLM transactions through escrow; on-lending PSL cap: 5% of total PSL (averaged across 4 quarters); SBR 4 layers (BL → ML → UL → TL; TL ideally empty).
Key Facts & References — Chapter 38 at a Glance
Background — NBFCs & Microfinance
Free38.1 Non-Banking Finance Companies (NBFC)
An NBFC is a company registered under the Companies Act engaged in loans and advances, acquisition of securities, leasing, hire purchase, insurance, or chit business — but not institutions whose principal business is agriculture, industrial activity, purchase/sale of goods, providing services, or sale/purchase/construction of immovable property.
- ▸Competitive edge: superior understanding of regional dynamics.
- ▸Well-developed collection systems and personalised services.
- ▸Lower transaction costs, quick decision-making, prompt service.
- ▸Housing Finance Companies (HFCs) are specialised NBFCs providing housing credit.
38.2 Microfinance & NBFC-MFIs
Microfinance provides small loans and financial services to poor and low-income households to promote financial inclusion, increase income levels, and improve living standards.
- ▸Delivered through SCBs, SFBs, RRBs (direct + through BCs and SHGs).
- ▸Cooperative banks, NBFCs, and MFIs registered as NBFCs.
- ▸9 NBFC-MFIs have been licenced to start universal/small finance banks.
- ▸NBFC-MFIs hold ~30%+ share of India's microfinance sector.
38.3 Bank Finance to NBFCs — General Framework
Bank borrowings are a major source of funds for NBFCs including NBFC-MFIs. This widens the reach of institutional credit to sectors/areas not fully covered by banks. Most aspects of bank financing to NBFCs have been deregulated; RBI has issued separate guidelines for collaborative lending (Co-Lending Model).
Bank Finance to NBFCs — Eligibility, Restrictions & Exposure Caps
Free38.3.1 NBFCs Registered with RBI
Banks may extend need-based working capital facilities and term loans to all NBFCs registered with RBI engaged in infrastructure financing, equipment leasing, hire-purchase, loan, factoring, and investment activities. All NBFCs (including HFCs) must register with RBI except the following exempted categories:
38.3.2 Activities NOT Eligible for Bank Credit to NBFCs
✗ Bills discounted/rediscounted by NBFCs
Exception: Banks may rediscount bills from NBFCs arising from sale of commercial vehicles, two-wheelers, and three-wheelers — provided bills are drawn by manufacturer on dealers and represent genuine transactions.
✗ Investments of NBFCs in shares/debentures
Both current and long-term investments in any company/entity.
✗ All types of loans to subsidiaries/group entities
Loans and advances by NBFCs to their subsidiaries, group companies, or entities.
✗ Bridge loans / interim finance
Banks should not grant bridge loans of any nature against capital/debenture issues or pending raising of long-term funds.
✗ Collateral security of shares
Shares and debentures cannot be accepted as collateral for secured loans to NBFCs.
38.3.3 Restriction on Guarantees for Placement of Funds with NBFCs
Banks should not execute guarantees covering inter-company deposits/loans, thereby guaranteeing refund of any type of deposits/loans accepted by NBFCs/firms from other NBFCs/firms, irrespective of source (including trusts and institutions). Guarantees should not be issued to indirectly enable placement of deposits with NBFCs.
Exception: Banks can provide partial credit enhancement (PCE) to bonds issued by NBFC-ND-SIs and HFCs.
38.3.4 Prudential Ceilings for Exposure of Banks to NBFCs
| Category | Exposure Ceiling |
|---|---|
| Single NBFC (excluding gold loan companies) | Maximum 20% of the bank's Tier I capital |
| Group of connected NBFCs / group of connected counterparties with NBFCs | Maximum 25% of the bank's Tier I capital |
| Single NBFC predominantly lending against gold jewellery (≥50% of financial assets) | Maximum 7.5% of Tier I + Tier II capital; up to 12.5% if additional exposure is for on-lending to infrastructure sector |
| NBFCs with gold loans ≥50% of total financial assets (aggregate) | Banks must have an internal sub-limit within the overall NBFC limit |
On-Lending Model & NBFC-MFI Definition & Prudential Norms
Members Only38.4 Bank Loans to NBFCs for On-Lending
Banks can extend loans to NBFCs for the purpose of on-lending to the priority sectors. This mode is not applicable to RRBs, UCBs, SFBs, and LABs.
(a) Loans to MFIs (NBFC-MFIs, Societies, Trusts, etc.)
Banks other than SFBs may extend credit to registered NBFC-MFIs and other MFIs (Societies, Trusts) which are members of RBI-recognised SROs for the sector, for on-lending to individuals and members of SHGs/JLGs. Eligible for priority sector classification.
(b) Loans to NBFCs (other than MFIs)
Bank credit to registered NBFCs for on-lending is eligible for priority sector classification under respective categories, subject to specified conditions.
(c) Loans to HFCs
Bank credit to HFCs approved by NHB for refinance, for on-lending for purchase/construction/reconstruction of individual dwelling units or for slum clearance/rehabilitation — eligible as priority sector.
(d) Cap on On-Lending
Bank credit to NBFCs (including HFCs) for on-lending under (b) and (c) should be within 5% of total priority sector lending, averaged across four quarters.
38.5.1 Definition — NBFC-MFI
An NBFC-MFI is a non-deposit taking NBFC (other than a company licensed under Section 8 of the Companies Act, 2013) that fulfills:
38.5.2 MFIs Exempted from Registration with RBI
MFIs fulfilling all three of the following are exempted:
- ▸(i) Licensed under Sec. 8 of the Companies Act, 2013 (Sec. 25 of the 1956 Act)
- ▸(ii) Providing credit not exceeding ₹50,000 for a business enterprise and ₹1,25,000 for a dwelling unit to any poor person
- ▸(iii) Does not accept public deposits as defined in RBI Directions
38.5.3 Prudential Norms for NBFC-MFIs
(a) Capital Adequacy
Applicable CRAR norms as prescribed by RBI from time to time.
(b) Asset Classification
- ▸Standard asset: No default perceived; normal risk.
- ▸Non-performing asset: Interest/principal overdue ≥ 90 days.
(c) Provisioning Norms
- ▸Aggregate loan provision ≥ higher of: 1% of outstanding loan portfolio, OR
- ▸50% of aggregate instalments overdue > 90 days & < 180 days, and 100% of instalments overdue ≥ 180 days.
- ▸CRGFTLIH-guaranteed NPAs: No provision for guaranteed portion.
Pricing, Multiple-Lending, Fair Practices & NBFC-MFI as Channelising Agent
Members Only38.5.4 Membership of CIC
Every NBFC-MFI must be a member of all Credit Information Companies (CICs), provide timely and accurate data to them, and use data available with CICs.
38.5.5 Pricing of Credit
38.5.6 Multiple-Lending, Over-Borrowing & Ghost-Borrowers
(i) Lending to individuals
NBFC-MFIs can lend to individuals — whether or not a member of JLG/SHG.
(ii) Membership restriction
A borrower cannot be a member of more than one SHG/JLG.
(iii) Lender limit
Not more than two NBFC-MFIs shall lend to the same borrower.
(iv) Moratorium
Moratorium before the first instalment must be at least equal to the frequency of instalments.
(v) Loans in violation
Loans given in violation of regulations to be recovered only after all prior loans are paid.
38.5.7 Fair Practices Code (FPC) for NBFC-MFIs
The Fair Practices Code for NBFCs is applicable to NBFC-MFIs in addition to the specific MFI Code of Conduct prescribed by RBI/SRO.
38.5.8 Monitoring of Compliance
Both NBFC-MFIs themselves and banks lending to NBFC-MFIs shall monitor compliance. All NBFC-MFIs must become a member of at least one SRO recognised by RBI and comply with its Code of Conduct.
38.6 NBFC-MFI — Channelising Agent for Special Government Schemes
NBFC-MFIs can act as channelising agents under special schemes of Central/State Government agencies — leveraging their last-mile reach for government-sponsored financial inclusion programmes.
Co-Lending Model (CLM)
Members OnlyIn November 2020, RBI revised its guidelines for co-origination as the Co-Lending Model (CLM) — aimed at improving credit flow to the priority sector with greater operational flexibility. Banks take their share of individual loans on a back-to-back basis.
CLM Applicability & Exclusions
- ▸Available to: All banks except SFBs, RRBs, UCBs, and LABs.
- ▸Excluded: Foreign banks (including WOS) with less than 20 branches.
- ▸Prohibited: Banks cannot enter CLM with an NBFC belonging to the promoter group.
- ▸Permitted with: All registered NBFCs including HFCs — based on a prior agreement.
38.7.1 Basic Aspects of CLM
38.7.2 Customer Related Issues
38.7.3 Other Operational Aspects
Scale Based Regulation, Chapter Summary & Flashcards
Members Only38.8 Framework for Scale Based Regulation (SBR) for NBFCs
RBI put in place a revised regulatory framework for NBFCs effective October 01, 2022. The SBR framework encompasses capital requirements, governance standards, and prudential regulation based on size, activity, and perceived riskiness.
| Layer | Abbreviation | Key Note |
|---|---|---|
| Base Layer | NBFC-BL | Largest in number; lowest perceived risk; lighter regulation |
| Middle Layer | NBFC-ML | SPD and IDF-NBFC always remain here; higher regulation |
| Upper Layer | NBFC-UL | Systemically important; near-bank regulation; identified by RBI |
| Top Layer | NBFC-TL | Ideally expected to be empty; extreme supervisory concern |
38.8.2 Categorisation of NBFCs Carrying Out Specific Activity
- ▸NBFC-ICC, NBFC-MFI, NBFC-MGC could lie in any of the layers (BL, ML, or UL).
- ▸SPD (Standalone Primary Dealer) and IDF-NBFC will always remain in the Middle Layer.
- ▸Government-owned NBFCs shall be placed in Base Layer or Middle Layer.
Chapter 38 in 6 Lines
- NBFCs have a competitive edge in regional reach, quick decisions, and lower transaction costs; banks can extend working capital and term loans to all registered NBFCs for eligible activities.
- Prohibited bank finance to NBFCs: bills discounting (barring CV/2W/3W exceptions), investments in shares/debentures, loans to subsidiaries, bridge loans, and advances against shares as collateral.
- NBFC exposure caps: single NBFC 20% Tier I; group 25% Tier I; gold loan NBFC 7.5% Tier I+II (extendable to 12.5% for infrastructure); on-lending PSL cap: 5% of total PSL averaged across 4 quarters.
- NBFC-MFI: min NOF ₹5 cr (NE: ₹2 cr); qualifying assets ≥85%; first cycle ≤₹75,000, subsequent ≤₹1,25,000; max household income ₹1,25,000 rural / ₹2,00,000 urban; total indebtedness ≤₹1,25,000; margin cap 10%/12%; max 2 NBFC-MFIs to same borrower.
- Co-Lending Model (CLM, Nov 2020): NBFC retains ≥20% of individual loans; all transactions through escrow with bank; NBFC is single interface for customer; complaints resolved within 30 days; not applicable to SFBs, RRBs, UCBs, LABs, or foreign banks with <20 branches.
- SBR Framework (effective Oct 2022): 4 layers — BL (lightest regulation) → ML (SPD/IDF always here) → UL (near-bank regulation) → TL (ideally empty); NBFC-ICC/MFI/MGC can be in any layer; govt-owned NBFCs in BL or ML.
Flashcards — Chapter 38
1. What are the four categories of activities in which banks can extend working capital and term loans to NBFCs?▼
2. Name any four categories of NBFCs exempted from registration with RBI.▼
3. Can banks finance the investments of NBFCs in shares and debentures?▼
4. What is the single NBFC exposure ceiling for banks (excluding gold loan companies)?▼
5. What is the exposure ceiling for a group of connected NBFCs?▼
6. What is the exposure ceiling for a gold loan NBFC (≥50% of financial assets in gold loans)?▼
7. What is the on-lending PSL cap for bank credit to NBFCs/HFCs?▼
8. What is the minimum Net Owned Fund requirement for an NBFC-MFI?▼
9. What percentage of net assets must be qualifying assets for an NBFC-MFI?▼
10. What are the loan amount ceilings for a qualifying asset under NBFC-MFI norms?▼
11. What is the household income ceiling for a qualifying asset (rural)?▼
12. How many NBFC-MFIs can lend to the same borrower simultaneously?▼
13. What is the margin cap for a large NBFC-MFI (portfolio > ₹100 crore)?▼
14. What is the maximum processing charge an NBFC-MFI can levy?▼
15. What is the minimum share that an NBFC must retain on its books under the Co-Lending Model?▼
16. Name the two options available to a bank under the Master Agreement in CLM.▼
17. Who is the single point of interface for customers under CLM?▼
18. Within how many days must a complaint registered by a borrower with the NBFC be resolved under CLM?▼
19. How should all bank-NBFC transactions (disbursements/repayments) under CLM be routed?▼
20. Name the four layers of the SBR framework for NBFCs.▼
21. Which NBFCs always remain in the Middle Layer under SBR?▼
22. When did the SBR framework for NBFCs become effective?▼
Discussion
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