Digital Lending Guidelines including FLDG Framework

The framework for the First Loss Default Guarantee (FLDG) has received clearance from the Reserve Bank of India (RBI). On Thursday, 8th June 2023 the statement was delivered during the second bimonthly monetary policy results. Popularly, the FLDG plan enables collaboration between Indian NBFCs and banks and fintechs. This ruling is seen favourably by data-tech NBFCs and fintechs. Additionally, the action will enhance the environment for online financing.

Key Takeaways:

1. Cap on FLDG (5%)
FLDG cover on any outstanding portfolio which is specified upfront shall not exceed five per cent of the amount of that loan portfolio
2. FLDG arrangement can be between
a. RE and LSP
b. Two Regulated Entities
3. FLDG should be part of the agreement including
a. Extent of cover
b. Form in which FLDG cover
c. Timeline for invocation
4. Forms of FLDG
a. Cash deposited with the RE
b. FDs maintained with a Bank with a lien marked
c. Bank Guarantee
5. Recognition of NPA
a. NPA recognition should be done irrespective of FLDG cover available at portfolio level.
b. FLDG cannot be set off against individual loans
c. Incase of recovery against NPAs for which DLG has been invoked and realised can be shared with FLDG provider
6. FLDG Invocation
a. RE can invoke FLDG within a max overdue period of 120 days
7. Tenor of FLDG
a. The period for which the FLDG agreement will remain in force shall not be less than the longest tenor of the loan in the underlying loan portfolio
8. Disclosure Requirements
a. LSPs shall publish on their website the total number of portfolios and the respective amount of each portfolio on which DLG has been offered.
9. Due Diligence
a. REs shall put in place a Board approved policy before entering into any FLDG arrangement. Such policy shall include, at the minimum, the eligibility criteria for FLDG provider, nature and extent of FLDG cover, process of monitoring and reviewing the FLDG arrangement, and the details of the fees, if any, payable to the DLG provider.
b. FLDG arrangement shall not act as a substitute for credit appraisal requirements and robust credit underwriting standards need to be put in place irrespective of DLG cover.
c. Every time an RE enters into or renews a FLDG arrangement, it has to assess LSPs capacity to pay

This would include a declaration, certified by the statutory auditor, on the aggregate FLDG amount outstanding, the number of REs and the respective number of portfolios against which FLDG has been provided. The declaration shall also contain past default rates on similar portfolios.

Impact of this guideline

Digital Lending by Fintechs, which had ebbed due to lack of clarity, will scale well.
Funding in Digital Lending Fintechs will increase.
Banks will have to create proper frameworks for adhering to these guidelines.
LSPs will have to publish on their website the total number of portfolios and the respective amt of each portfolio on which DLG has been offered. This would expose their portfolio for public scrutiny.
LSPs will have to expose all their relationships and portfolios (including default) with all REs. While it would increase transparency, it may open up all LSP – RE agreements for review by competitors.