RBI gives green signal to first loss default guarantee (FLDG) framework; here’s how will fintech, banks, NBFCs benefit

In its circular, RBI said, “arrangements between Regulated Entities (REs) and Lending Service Providers (LSPs) or between two REs involving default loss guarantee (DLG), commonly known as FLDG, has since been examined by the Bank and it has been decided to permit such arrangements subject to the guidelines laid down.”

It added, “FLDG arrangements conforming to these guidelines shall not be treated as ‘synthetic securitization’ and/or shall also not attract the provisions of ‘loan participation.”

Here’s how FLDG scheme will help financial institutions: 

On the development, Aditya Damani, Founder & CEO, of Credit Fair said, “As per the first loss default guarantee (FLDG) model, the first hit on a default is taken by the fintech firm that originated the loan. It’s a positive development which will strengthen credit penetration and boost the digital lending ecosystem.”

Along similar lines, Atul Kumar Goel, MD and CEO of Punjab National Bank (PNB) said, “RBI has decided to come out with a regulatory framework for permitting First Loss Default Guarantee (FLDG) arrangements in Digital Lending which will promote more transparency and discipline in digital lending environment. Similarly, proposing the framework for widening of scope of resolution of stressed assets indicate that RBI is right on the track of instilling harmonization across Regulated Entities.”

Meanwhile, Karthik Srinivasan, Senior Vice President, Group Head – Financial Sector Ratings, ICRA said, “While most of the regulated entities have already stopped taking FLDGs on new loans originated by non-regulated fin-techs, the proposal to announce a regulatory framework will bring in more clarity as digital lending is going to stay and increase substantially in scale. if non-regulated entities are allowed to offer FLDGs with necessary safeguards, it could provide further impetus to digital lending.”

Further, Subhrangshu Neogi – Executive Director & Co Founder , Escrowpay said,”RBI’s fresh guidelines are a welcome move and extremely encouraging for the ecosystem. This will further enhance deeper partnerships and collaboration between legacy institutions Banks, regulated entities, NBFCs and new age fintech’s thus helping further democratise access to credit and fuel growth for the unserved and underserved.”

Neogi added, “As pioneers in digital escrow solutions, this continues to be an exciting segment for us and we will continue to enable this ecosystem powering secure collections and transactions.”

The Framework: 

Under the framework, RBI directed that RE shall ensure that the total amount of DLG cover on any outstanding portfolio which is specified upfront shall not exceed 5% of the amount of that loan portfolio.

In the case of implicit guarantee arrangements, the DLG Provider shall not bear a performance risk of more than the equivalent amount of 5% of the underlying loan portfolio.

Also, the RE shall invoke DLG within a maximum overdue period of 120 days, unless made good by the borrower before that.

In terms asset quality, recognition of individual loan assets in the portfolio as NPA and consequent provisioning shall be the responsibility of the RE as per the extant asset classification and provisioning norms irrespective of any DLG cover available at the portfolio level. The amount of DLG invoked shall not be set off against the underlying individual loans. Recovery by the RE, if any, from the loans on which DLG has been invoked and realized, can be shared with the DLG provider in terms of the contractual arrangement.

“It is reiterated that any DLG arrangement shall not act as a substitute for credit appraisal requirements and robust credit underwriting standards need to be put in place irrespective of DLG cover,” RBI said.

In August last year, after taking into account the inputs received from a diverse set of stakeholders, RBI set up a regulatory framework to support the orderly growth of credit delivery through digital lending methods while mitigating regulatory concerns.

This regulatory framework is based on the principle that lending business can be carried out only by entities that are either regulated by the Reserve Bank or entities permitted to do so under any other law.

Updated: 08 Jun 2023, 10:54 PM IST