RBI allows FLDG arrangements, caps cover at 5% of loan portfolio

RBI has allowed First Loss Guarantee Arrangements (FLDG) between two Regulated Entities (REs) or between a Regulated Entity and its Lending Service Providers (LSPs) for digital lending.

Thus, arrangements that include a Loss Default Guarantee (DLG) will not be treated as “synthetic securitization” and will not attract “co-loan” provisions. The guidelines are effective immediately.

“REs shall ensure that the total amount of DLG coverage on any outstanding portfolio specified in advance shall not exceed 5 percent of the amount of such loan portfolio,” the central bank said, adding that even in the case of an implied guarantee arrangement, the DLG provider will not assume performance risk for more than than 5 percent of the core portfolio.

The need for FLDG

The Reserve Bank of India has defined DLG as a contractual arrangement in which the partner entity guarantees to compensate RE for loss by default up to a certain percentage of the loan portfolio. This includes other similar implied guarantees associated with portfolio performance.

As part of monetary policy on Thursday, the Reserve Bank of India (RBI) announced to allow FLDG arrangements with a view to maintaining a balance between innovation and prudent risk management. She added that the framework will facilitate the orderly development of the digital lending ecosystem and enhance credit penetration.

business line May reported, on May 29th, that a framework will be released soon that will likely be more enabling than blocking. Digital lenders have presented to the regulator about the urgency of the situation and why allowing FLDG arrangements is crucial, given that the industry is centered around it and many companies have built their business models on it.

“The Reserve Bank of India (RBI) has been engaging with several stakeholders on DLG and has taken most of the comments into account,” said Jatinder Handu, CEO, Digital Lenders Association of India (DLAI). He added that the guidelines leave limited room for ambiguity and that a well-defined structure will make it easier for all players to participate in an efficient and transparent manner.

FLDG domain

DLG arrangements must be backed by an express contract, detailing the extent of the DLG’s coverage, the form in which the DLG’s cover is maintained and the schedule for the DLG’s call-up, as well as other disclosures, the RBI said.

Resident traders can accept DLG arrangements in the form of cash deposits, fixed deposits with a specific lien in favor of RE and bank guarantees. They will be responsible for the NPA’s recognition of individual loan assets in the portfolio and consequent provisioning, according to current standards regardless of any DLG coverage at the portfolio level.

“The amount of DLG called against the underlying individual loans will not be discounted,” the Reserve Bank of India said. It added that any refunds by REs, from loans invoked and realized by DLG, could be shared with the DLG provider.

“The RE is required to call the DLG within a maximum delay of 120 days, unless it has been fulfilled by the borrower before then.” DLG agreements shall remain in effect for as long as the longest term of the loan in the underlying portfolio.

Real estate dealers will need to ensure that partner service providers publish data on the total number of portfolios and the amount for each portfolio for which the DLG has been offered. They would also need to draw up a board-approved policy and look up information such as the total amount of DLG owed, past default rates, the number of REs and wallets against which the DLG was provided, before entering into an arrangement.

Karthik Srinivasan, Senior Vice President, Group Head – Financial Sector Ratings, said the standards will provide more clarity and provide further impetus for digital lending.

Achala Jethmalani, Economist, RBL Bank

Rajani Sinha, Chief Economist, CareEdge

Mitul Shah, Head of Research, Reliance Securities