- By Priyanka Payal
- Fri, 09 Jun 2023 12:24 PM (IST)
- Source:JND
In its three-day RBI monetary policy committee meeting which concluded Thursday (June 8), the central bank introduced guidelines on Default Loss Guarantee arrangements in Digital Lending, a move aimed at facilitating the development of the digital lending ecosystem and enhancing credit penetration in the economy. The decision is likely to further promote responsible innovation and prudent risk management.
The RBI has introduced a limit of 5% on the first loan default guarantee provided by fintech to their lending partners. The bank said that regulated entities should ensure that the total default guarantee shall not exceed 5% of the portfolio amount. The RBI said: RE shall ensure that the total amount of DLG cover on any outstanding portfolio which is specified upfront shall not exceed five per cent of the amount of that loan portfolio. In the case of implicit guarantee arrangements, the DLG Provider shall not bear performance risk of more than the equivalent amount of five per cent of the underlying loan portfolio.
In a word of caution, the RBI said 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 realised, can be shared with the DLG provider in terms of the contractual arrangement.
The Reserve Bank of India has granted its approval for First Loss Default Guarantee (FLDG) framework. FLDG refers to arrangements between Regulated Entities (REs) and Lending Service Providers (LSPs) or between two REs involving default loss guarantee (DLG).
Meanwhile, Default Loss Guarantee is a contractual arrangement between a regulated entity and an entity meeting prescribed norms, under which the latter guarantees to compensate the RE, loss due to default up to a certain percentage of the loan portfolio specified upfront.
According to the RBI notification dated June 8, 2023, these guidelines are applicable to DLG arrangements entered in ‘Digital Lending’ operations undertaken by the following entities (hereinafter referred to as ‘Regulated Entities’):
1. All Commercial Banks (including Small Finance Banks),
2. Primary (Urban) Co-operative Banks, State Co-operative Banks, Central Co-operative Banks; and
3. Non-Banking Financial Companies (including Housing Finance Companies)
As per the guidelines, a RE may enter into DLG arrangements only with a Lending Service Provider (LSP) or other RE with which it has entered into an outsourcing (LSP) arrangement. Further, the LSP providing DLG must be incorporated as a company under the Companies Act, 2013.
The RBI said: “While issuing the Press Release dated August 10, 2022 on Implementation of the Recommendations of the Working group on Digital Lending, it was stated that the recommendation pertaining to First Loss Default Guarantee (FLDG) is under examination with the Reserve Bank. Based on extensive consultations with various stakeholders, and in tune with our objective of maintaining a balance between innovation and prudent risk management, it has been decided to put in place a regulatory framework for permitting Default Loss Guarantee arrangements in Digital Lending.”
