Co-lending allows two regulated lenders to finance the same portfolio of borrowers while sharing the economics and credit exposure. The model can combine the origination and distribution capabilities of an NBFC with the funding capacity of a bank or another regulated entity.

But the arrangement becomes more complicated when borrowers start defaulting. If one lender classifies the account as a non-performing asset (NPA), can the other continue treating its exposure as standard? Can one lender shift the loss to its partner through a contractual arrangement? And does a default loss guarantee (DLG) mean the co-lender is effectively insulated from credit risk?

The answer under the Reserve Bank of India (Co-Lending Arrangements) Directions, 2025 is that co-lending does not eliminate the underlying credit risk of either lender. The framework deliberately requires both lenders to retain meaningful exposure and now imposes a common borrower-level approach to asset classification.

The 2025 framework changed the co-lending landscape

The RBI issued the Co-Lending Arrangements Directions, 2025 on 6 August 2025. They came into force from 1 January 2026, although regulated entities could adopt them earlier. The framework applies to commercial banks other than Small Finance Banks, Local Area Banks and Regional Rural Banks, All-India Financial Institutions, and NBFCs including Housing Finance Companies.

This is broader than the earlier 2020 framework, which primarily governed co-lending between banks and NBFCs for priority-sector lending. The 2025 Directions provide a general regulatory framework for co-lending arrangements between eligible regulated entities.

Under the new framework, a co-lending arrangement is an agreement under which an originating regulated entity and a partner regulated entity jointly fund a portfolio of secured or unsecured loans in a pre-agreed proportion, with revenue and risk sharing.

Each lender must retain its own skin in the game

One of the most important safeguards is the minimum retention requirement.

Each regulated entity participating in a co-lending arrangement must retain at least 10% of the individual loan exposure in its own books. This prevents a structure in which one entity effectively originates loans while transferring virtually all credit risk to its partner.

Consider a ₹1 crore loan jointly funded by two eligible regulated entities. If their agreed funding proportions are 80:20, each must nevertheless retain at least the required minimum share of its exposure in its own books. The precise structure must therefore be designed so that both lenders continue to bear genuine credit exposure.

This is important when negotiating commercial arrangements. A co-lending agreement cannot be drafted simply as a mechanism for one lender to originate the loan while the other assumes the economic risk without retaining the exposure contemplated by the Directions.

What happens when the borrower defaults?

This is where the 2025 framework is particularly significant.

Under paragraph 33 of the Directions, asset classification is applied at the borrower level for the respective exposures under a co-lending arrangement. If either regulated entity classifies its exposure to the borrower as SMA or NPA because of default in the co-lending exposure, the same classification must apply to the other regulated entity's exposure to that borrower.

In practical terms, one lender cannot continue treating its portion as a standard asset merely because it has received payments differently or has not independently reached the same conclusion.

The lenders must therefore have a robust information-sharing mechanism. The Directions require relevant classification information to be shared on a near-real-time basis and, in any event, by the end of the next working day.

This makes operational integration just as important as the funding arrangement itself.

Does a DLG shift the default risk?

Not entirely. The 2025 Directions permit the originating regulated entity to provide a Default Loss Guarantee of up to 5% of the outstanding loans under the co-lending arrangement. Such DLG arrangements are to be governed, with necessary adaptation, by the RBI's Digital Lending Directions.

A DLG therefore provides limited credit protection; it does not convert the partner lender's exposure into a risk-free asset.

For example, if the permitted DLG covers 5% of the relevant outstanding portfolio, losses beyond that protection remain subject to the underlying allocation of risk between the co-lenders. More importantly, the existence of a DLG does not permit either lender to ignore the RBI's asset-classification and provisioning requirements.

The distinction matters because credit enhancement is not the same thing as elimination of credit risk.

Who handles recovery?

The originating and partner entities can allocate operational responsibilities contractually, but the arrangement must clearly establish who performs functions such as sourcing, servicing, monitoring and recovery.

The co-lending agreement must specify the segregation of responsibilities, timelines for exchanging critical information, customer-interface arrangements and grievance-redressal mechanisms. The borrower's loan agreement must also identify the relevant roles and the entity acting as the single point of interface with the customer.

Therefore, a borrower should not be left trying to determine which lender is responsible for servicing the account after default.

From the lenders' perspective, the allocation of recovery responsibility also needs to be operationally realistic. A contractual right to recover is of limited value if the parties have not established information-sharing, collections and escalation procedures.

What if the co-lending relationship itself breaks down?

The RBI framework anticipates this possibility.

The Directions require regulated entities to maintain a business continuity plan so that services to borrowers continue until repayment even if the co-lending arrangement between the lenders is terminated.

Further, if a loan exposure originated under co-lending is subsequently transferred to a third party, or transferred between the co-lenders, the transaction must comply with the applicable RBI framework governing transfer of loan exposures. A transfer to a third party requires the mutual consent of the originating and partner regulated entities.

The termination of a commercial partnership between lenders therefore cannot simply become a disruption for the borrower.

The lender cannot outsource regulatory responsibility

Co-lending does not permit a bank or NBFC to treat its partner as a substitute for its own regulatory obligations.

Each regulated entity must have a credit policy addressing co-lending arrangements, including internal portfolio limits, target borrower segments, due diligence of partners, customer service and grievance redressal. The loans are also subject to internal and statutory audit requirements.

The RBI framework also requires the parties to comply with applicable KYC and fair-practice requirements. A partner regulated entity may rely on the originating entity for the Customer Identification Process in accordance with the KYC framework, but this operates within the regulatory conditions and does not remove the broader compliance responsibilities of the regulated entities.

The practical allocation of risk

When a co-lending loan turns bad, the correct question is therefore not “Which lender bears the loss?”

Both lenders have exposure. The more useful questions are:

What proportion of the loan does each lender retain? What contractual risk-sharing arrangements exist? Is a permitted DLG in place? Has the account been classified consistently? Who is responsible for recovery? And have the lenders exchanged the necessary information promptly?

The answers will determine the practical distribution and management of the loss.

For lenders entering these arrangements, the documentation should therefore go well beyond funding percentages. It should address underwriting standards, information access, servicing, recovery, borrower communication, default management, DLG, audit rights, termination, business continuity and transfer of exposures.

Conclusion

RBI's 2025 framework makes one principle clear: co-lending is a sharing of credit exposure, not a way of transferring away responsibility for credit risk.

Each regulated entity must retain a minimum 10% share of the individual loan, both lenders must reflect the borrower's SMA or NPA classification consistently, and a permitted DLG provides only limited protection rather than a complete shield against losses.

For banks and NBFCs, the real risk is therefore not simply the borrower's default. It is also the possibility that weak documentation, delayed information-sharing or unclear recovery responsibilities make an already bad loan harder to manage.

A well-structured co-lending model should answer those questions before the first loan goes bad.