RBI permits loan default guarantee in digital lending
ContextThe Reserve Bank of India (RBI) has allowed default loss guarantee (DLG), a safety-net arrangement among banks, non-banking finance companies, and lending service providers (LSPs) in the digital lending space.
- DLG is also known as ‘First Loss Default Guarantee (FLDG)’.
- Lending service providers are new-age players who use technology platforms in the lending space.
- They are agents of a bank or NBFC who carry out one or more of a lender’s functions (in part or full) in customer acquisition, underwriting support, pricing support, disbursement, servicing, monitoring, recovery of specific loan or loan portfolio on behalf of REs.
- FLDG is an arrangement whereby a third party such as a financial technology (fintech) player (LSP) compensates lenders if the borrower defaults.
- The LSP provides certain credit enhancement features such as first loss guarantee up to a pre-decided percentage of loans generated by it.
- Offering FLDG acts to investors will work as a demonstration of its underwriting skills.
- From the perspective of the lender, it ensures the platform’s skin in the business.
- The RBI, after examining FLDG, permitted the arrangements between banks and fintechs or between two regulated entities (REs).
- The central bank said an RE can enter into DLG arrangements only with an LSP or other REs with which it has entered into an outsourcing (LSP) arrangement.
- The LSP-providing DLG must be incorporated as a company under the Companies Act, 2013.
- The RBI issued guidelines on digital lending in September 2022, but it did not provide clarity on the FLDG structure.
- In the absence of clear directions, regulated entities like banks had stopped entering into such arrangements with fintech players, posing a threat to their business.
- The fintech industry was demanding that the RBI should allow FLDG arrangements.
- The RBI nod for compensating banks in case of default is expected to boost fintech activity in the financial sector.