Fintech Lending: RBI's New Guidelines on FLDG

Introduction

Through June 08, 2023 circular, the RBI permitted First Loss Default Guarantee (FLDG), a crucial enabler for NBFC-fintech partnership.

Here's a byte-sized summary of the key guidelines, in our view, for leaders on the move

What is FLDG?

Also known as Default Loss Guarantee (DLG), is a contractual arrangement with a regulated lender for loss compensation due to default, up to a certain percentage of a loan portfolio

DLG Provider Eligibility

DLG arrangements can only be made with a Lending Service Provider (LSP) or other regulated entities (REs) under an outsourcing arrangement.

The LSP must be incorporated under the Companies Act, 2013.

Extent of DLG Cover

Total DLG cover on any outstanding portfolio should not exceed 5% of that loan portfolio.

For implicit guarantee arrangements, the DLG Provider's performance risk borne can't exceed 5% of the underlying loan portfolio.

Forms of DLG

DLG can be accepted in the form of

• cash deposit with RE (Regulated Entity)
• fixed deposits with a scheduled commercial bank with a lien marked in favour of the RE or
• bank guarantee in favour of the RE

Invocation and Tenor of DLG

DLG must be invoked within 120 days of overdue period unless made good by the borrower within that.

The DLG agreement must last at least as long as the longest loan in the underlying portfolio.

Not a substitute for Credit Underwriting

Robust credit underwriting standards need to be put in place irrespective of DLG cover

DLG Provider Evaluation

Prior to partnering, the REs must obtain sufficient information to ensure the DLG provider can honor it. At the minimum, auditor certified declaration from the DLG provider on

• the aggregate DLG amount outstanding
• the number of REs
• the respective number of portfolios against which DLG has been provided
• past default rates on similar portfolios

Scope of the Guidelines

Applicable to DLG arrangements entered in ‘Digital Lending’ operations undertaken by all Regulated Entities (RE)

• All Commercial Banks (including Small Finance Banks)
• Primary (Urban) Co-operative Banks, State Co-operative Banks, Central Cooperative Banks; and
• Non-Banking Financial Companies (including Housing Finance Companies)

Source

Recommendations of the Working group on Digital Lending – Implementation' dated August 10, 2022

RBI Guidelines on Default Loss Guarantee (DLG) in Digital Lending dated June 08, 2023