RBI gives green signal to first loss default guarantee (FLDG) framework

Subject : Economy

Section: Monetary Policy

FLDG:

FLDG allows Indian fintechs to partner with banks and NBFCs
Banks and NBFC act as the third party in arrangement between customer (who takes loan) and the Fintec company
The first hit on a default is taken by the fintech firm that originated the loan.

Key Points:

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
FLDG arrangements conforming to these guidelines shall not be treated as ‘synthetic securitization’ and/or shall also not attract the provisions of ‘loan participation.”
Regulated and non-regulated LSPs:
- For regulated LSPs (Fintec) the proposal to announce a regulatory framework will bring in more clarity as digital lending is going to stay and increase substantially in scale.
- No clarity for non-regulated LSPs, if non-regulated entities are allowed to offer FLDGs with necessary safeguards, it could provide further impetus to digital lending.
The regulatory framework:
- It 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.
- 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.

Impact on fintech, banks, NBFCs:

Big positive for data-tech NBFCs and fintechs as the move will strengthen the digital lending ecosystem.
Allows synergies between Fintec and Banks to strengthen credit penetration and boost the digital lending ecosystem.
Regulations will promote more transparency and discipline in digital lending environment