RBI Approves First Loss Default Guarantee Programme
The first loss default guarantee (FLDG) programme which allows fintech companies in India to form partnerships with banks and non-banking financial companies (NBFCs) has been approved by the Reserve Bank of India (RBI).
Previously, the RBI had expressed openness to the concept of FLDG in its digital lending Guidelines. However, this is the first explicit approval of such a product by the banking regulator. The RBI has set a cap on the FLDG amount, limiting it to 5 per cent of the total loan value.
According to the RBI circular, the FLDG programme helps banks and NBFCs mitigate potential losses and gain confidence in fintech companies' understanding of credit risk. Under this programme, fintech's assist in recovering losses incurred when customers default on payments.
While some fintechs offer coverage for only the first month, more aggressive partnerships have emerged where fintechs cover losses for up to three months of defaults, known as the default loss guarantee (DLG).
Another arrangement involves fintechs compensating lenders for up to five loans in a portfolio of 100 loans, subject to the new 5 per cent cap. This arrangement ensures that lenders do not suffer losses as long as non-performing assets remain below 5 per cent.
Sanjay Swamy, Managing Partner at Prime Venture, expressed support for the 5 per cent cap, considering India's need for credit. He believes that fintechs and regulated entities have the opportunity to partner for more than just their own economic benefit, emphasising the importance of risk and reward sharing.
The circular clarifies that the fintechs facilitating this lending are not participants in lending or lenders themselves. The RBI had previously stated in the digital lending guidelines that only regulated entities should lend to end customers. The customer relationship should be direct with the lenders, and collections should also be remitted directly to the lender's account.
These guidelines apply to DLG arrangements entered into by commercial banks, primary (urban) cooperative banks, state cooperative banks, central cooperative banks, and NBFCs involved in digital lending operations.
As part of the due diligence, the RBI requires banks and NBFCs to establish a board-approved policy before entering into any DLG arrangement. This policy should include eligibility criteria for DLG providers, the extent of DLG coverage, the process for monitoring and reviewing the DLG arrangement, and details of any applicable fees payable to the DLG provider.
The CEO of the Digital Lenders Association of India (DLAI), Jatinder Handoo, believes that the circular provides clarity on the permissible structure for DLG arrangements, leaving little room for ambiguity. He expects the well-defined structure to facilitate effective and transparent participation by all players and enable them to make the best use of the DLG facility.
The 5 per cent cap may deter certain risk-averse financial institutions from participating in this emerging segment. However, it has been seen as a positive development by many fintech industry players, who see it as striking a balance between innovation and regulation. They anticipate that this formalisation of the FLDG arrangement will encourage the creation of innovative products to meet India's credit needs.
