RBI greenlights first loss default guarantee (FLDG), industry experts react

By Puja Sharma

A regulatory framework was released by the Reserve Bank of India (RBI) last week to permit default loss guarantee arrangements in digital lending. In terms of their lending arrangements with banks and non-banking financial companies, this is considered a major relief for FinTech companies.

The first loan default guarantee, or FLDG for short, is an agreement between a FinTech company and a regulated entity (RE), such as a bank or non-banking finance company, whereby the FinTech pays the RE a certain amount of compensation if a borrower defaults on their loan.

Under the digital lending norms, the RBI barred the first loss default guarantee arrangement. As part of this credit-risk sharing arrangement, a certain percentage of default loans of banks and NBFCs (registered entities) is guaranteed by a third party, a FinTech or lending service provider (LSP). When the digital lending guidelines were introduced, there was widespread anticipation regarding the removal of Full KYC (FLDG) requirements. This change is expected to elicit a positive reaction in the market, creating a more inclusive lending environment.

As FinTech companies increasingly seek NBFC licenses, we anticipate a strong performance by pure-play Lending Service Providers (LSPs). However, it is important to note that while FLDG may be permitted, further clarity is needed regarding the digital lending guidelines themselves.” said Nageen Kommu, CEO, of Digitap.

Questions arise around the responsibility for conducting KYC checks and underwriting, as well as the flow of funds from lenders’ accounts. Nevertheless, FLDG offers significant benefits, particularly for FinTechs who have the freedom to tailor their products.

Kommu added This empowers FinTechs to deliver a seamless customer experience without relying on lenders for every decision, ultimately fostering innovation and enhancing customer-centric lending practices.

A lending service provider or other entity with which the entity has an outsourcing arrangement may only enter into default loss guarantee arrangements with the entities under the new guidelines. Furthermore, the LSP providing default loss guarantee must be incorporated as a company under the Companies Act, 2013. The document indicates that entities may accept default loss guarantees in cash deposited with them, fixed deposits with commercial banks with liens against them, and bank guarantees.

“The recent announcement by RBI to establish a framework and regulations for facilitating Foreign Lending and Debt Guarantees (FLDG) is a commendable step that will significantly contribute to the expansion of the Digital Lending industry. Many Digital Lending companies encounter difficulties in securing local debt capital and managing liability issues,” said Anil Pinapala, CEO & Founder, FlexPay by Vivifi.

“The introduction of FLDG not only encourages banks to offer liquidity but also enables them to effectively mitigate risks through FLDG protection. This development will undoubtedly enhance the collaboration between banks and fintech/digital lending firms, bolstering their partnerships and overall stability.” Pinapala noted.

“The Guidelines on Default Loss Guarantee represent a progressive and forward-looking approach. They bring clarity to the functioning of default loss arrangements and acknowledge that both RE (regulated entities) and Non-RE can offer such guarantees.” Rohit Shrivastava, Head Compliance & Regulatory Affairs, Balancehero India.

This creates a fair playing field for both types of entities and promotes innovation in digital lending while ensuring responsible risk management by lending institutions. Importantly, these guidelines are designed to safeguard the interests of customers.

With the prescribed maximum threshold of 5% on the Default Loss Guarantee, lending entities and FinTech firms serving as Loan Service Providers (LSPs) will strive to enhance their services to keep the default loss requirement within the defined limit. This threshold acts as an incentive for continual improvement, benefiting borrowers and lenders alike.

“These guidelines will have a long-term impact on the lending landscape. They encourage transparency, fairness, and prudent risk management practices, ultimately leading to enhanced customer protection. By embracing these guidelines, the digital lending sector can evolve in a manner that promotes trust, innovation, and sustainable growth” Shrivastava said.