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Bank-NBFC co-lending pacts may be expanded to aid MSMEs

March 16, 2026 4 min read Economics Polity & Governance GS Paper 3 (Indian Economy Banking MSMEs)
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What Happened

  • A parliamentary standing committee has recommended expanding bank-NBFC co-lending partnerships to help MSMEs access cheaper credit and bridge India's significant MSME credit gap.
  • The committee also proposed listing profitable Regional Rural Banks (RRBs) on stock exchanges to improve their capital base and governance.
  • Recommendations include reinforcing state-run general insurance companies and developing climate risk insurance products.
  • The panel highlighted a significant and persistent credit gap for small businesses, with demand for formal credit far exceeding supply.
  • Business correspondents (BCs) were identified as a critical channel to extend formal banking and insurance services to rural and semi-urban areas.

Static Topic Bridges

Co-Lending Model: Framework and Significance

The co-lending model (CLM), introduced by the Reserve Bank of India, enables banks and NBFCs to jointly originate loans to priority sector borrowers, combining the NBFC's last-mile reach with the bank's lower cost of funds. The model was formalised through the Co-Lending Model guidelines, first issued in 2018 (as co-origination) and significantly revised in November 2020.

  • Banks and NBFCs enter a master agreement specifying risk-sharing ratios; typically, the bank retains 80% and the NBFC retains 20% of the loan in their books.
  • The borrower pays a blended interest rate lower than what the NBFC would charge alone, as the bank's cheaper funds reduce the cost.
  • Applicable to priority sector lending (PSL) categories: agriculture, MSME, housing, and weaker sections.
  • RBI's CLM framework (2020) allows NBFCs to serve as originators and servicers, with banks providing back-end capital.
  • The World Bank estimates India's MSME credit gap at approximately $380 billion, affecting 60 million+ MSMEs.

Connection to this news: The parliamentary panel is recommending expansion of this model beyond its current PSL scope to more broadly cover MSME credit, which would unlock cheaper credit channels for millions of small businesses that currently depend on costlier informal or NBFC-only financing.

MSME Sector and Credit Access

Micro, Small and Medium Enterprises are defined under the MSMED Act, 2006, as amended in 2020, based on investment in plant and machinery/equipment and annual turnover. MSMEs contribute approximately 30% of India's GDP, 48% of exports, and employ over 110 million people, making credit access a central concern for inclusive economic growth.

  • Revised MSME classification (2020): Micro — investment up to ₹1 crore, turnover up to ₹5 crore; Small — investment up to ₹10 crore, turnover up to ₹50 crore; Medium — investment up to ₹50 crore, turnover up to ₹250 crore.
  • India has approximately 63 million MSMEs; formal credit penetration estimated at only 15-16% of total credit demand.
  • Key barriers to MSME credit: lack of collateral, informal cash flows, absence of formal financial records.
  • Government credit support instruments: CGTMSE (Credit Guarantee Fund Trust for Micro and Small Enterprises), Emergency Credit Line Guarantee Scheme (ECLGS), Mudra loans.
  • Budget 2025-26 enhanced MSME credit card limits and announced a ₹10,000 crore Fund of Funds.

Connection to this news: The credit gap for MSMEs — estimated at $380 billion — is the direct motivation for the parliamentary panel's recommendation to expand co-lending, which can leverage NBFC networks to deliver lower-cost, bank-funded credit to underserved small businesses.

Regional Rural Banks (RRBs) — Listing Rationale

Regional Rural Banks were established under the Regional Rural Banks Act, 1976, to extend banking services to rural areas and agricultural communities. Sponsored jointly by the central government (50%), state governments (15%), and sponsor commercial banks (35%), RRBs are hybrid institutions designed to combine local knowledge with formal banking infrastructure.

  • RRBs established under RRB Act, 1976; ownership structure: Centre 50%, State 15%, Sponsor Bank 35%.
  • As of recent consolidation, 43 RRBs operate across India (down from 196 through mergers).
  • RRBs serve approximately 700 districts, with a branch network exceeding 22,000 branches.
  • Listing profitable RRBs would allow them to raise capital from markets, improve governance through public disclosure norms, and reduce dependence on recapitalisation by sponsor banks and the government.
  • The recommendation aligns with NITI Aayog's earlier suggestions for privatisation and capital market access for public sector financial institutions.

Connection to this news: The parliamentary panel's listing recommendation targets capital adequacy gaps in RRBs that currently limit their ability to expand rural credit, directly complementing the co-lending recommendation by creating stronger institutional partners for rural MSME finance.

Key Facts & Data

  • India's MSME credit gap: estimated at $380 billion (World Bank), affecting 60 million+ MSMEs
  • MSME contribution to GDP: approximately 30%; to exports: approximately 48%; employment: 110 million+
  • Co-lending model revised guidelines: RBI circular, November 5, 2020
  • Typical bank-NBFC co-lending risk split: 80% bank, 20% NBFC
  • Number of RRBs after consolidation: 43 (operating across ~700 districts)
  • RRB ownership: Central Government 50%, State Government 15%, Sponsor Bank 35%
  • RRB branch network: 22,000+ branches
  • Business correspondents: serve as banking touchpoints in villages with populations below 5,000
  • CGTMSE covers collateral-free loans up to ₹5 crore for micro and small enterprises