Small finance banks (SFBs) are making a fresh push for being allowed to participate in co-lending arrangements with banks and non-banking financial companies (NBFCs) so that they can re-balance their loan portfolio amid the central bank relaxing priority sector lending (PSL) target for them.Currently, the Reserve Bank of India (RBI) allows lenders such as Commercial Banks, All-India Financial Institutions, and Non-Banking Financial Companies (including Housing Finance Companies) to enter into co-lending arrangements (CLAs). However, within the commercial banks category, Small Finance Banks, Local Area Banks and Regional Rural Banks are excluded.“Co-lending is one area where I believe the framework should evolve. Today, universal banks and NBFCs can co-lend, but SFBs are not part of that ecosystem,” said Baskar Babu R, MD & CEO, Suryoday Small Finance Bank and Chairman, Association of SFBs of India (ASFBI).Improving EfficiencyHe observed that extending the CLA facility to SFBs would strengthen credit delivery, improve capital efficiency and enable partnerships that leverage the strengths of respective lenders without compromising customer relationships.Babu emphasised that the biggest advantage would be the ability to enter specialised lending segments without having to build entirely new businesses from scratch.“Gold loans are a case in point. Rather than investing heavily in creating a nationwide gold loan franchise, an SFB could partner with an NBFC that already has deep expertise, trained personnel and an extensive branch network. The bank would contribute its low-cost funding and balance sheet, while the NBFC would originate and service customers.“In Maharashtra, we may have about 100 branches, whereas a specialised gold loan NBFC may have 1,000 touchpoints. It doesn’t make economic sense for us to open hundreds of branches for a single product. Co-lending allows each institution to play to its strengths,” he said.The aforementioned logic also applies to consumer durable finance and other niche retail lending segments where specialist lenders have already built scale.CLA involves an agreement between a lender which is originating the loans (due to its distribution reach and expertise in a particular lending category, but limited funds) and another lender (having enough funds to lend but not having expertise in a particular lending category) which is co-lending, to jointly fund a portfolio of loans, comprising either secured or unsecured loans, in a pre-agreed proportion, involving revenue and risk sharing.The RBI had lowered the priority sector lending (PSL) target for SFBs with effect from April 01, 2026, reducing the overall target from 75 per cent to 60 per cent of their Adjusted Net Bank Credit or Credit Equivalent of Off-Balance Sheet Exposures, whichever is higher. This was aimed at helping SFBs diversify their portfolio into secured lending business amid asset quality issues in the unsecured microfinance lending business.Co-lending between banksBeyond partnerships with NBFCs, SFBs are also urging the RBI to consider allowing co-lending between banks.The ASFBI Chairman said such a co-lending framework could simplify lending for customers while lowering operating costs. For instance, if a customer requires a ₹2 lakh microfinance loan but an SFB is comfortable lending only ₹1 lakh under its internal risk framework, another bank could fund the remaining amount under a single co-lending arrangement instead of forcing the borrower to approach multiple institutions.“The servicing cost is incurred only once because the customer deals with one institution. One lender may have a lower cost of funds while another has superior distribution. Both institutions benefit, and so does the customer,” Babu said.Bankers want the CLA framework to work in both directions—allowing SFBs to originate loans for larger banks while also participating in loans sourced by other institutions.Published on July 9, 2026