Default Loss Guarantee

Facts for Prelims

Default Loss Guarantee

News: The Reserve Bank of India (RBI) has allowed default loss guarantee (DLG), a safety-net arrangement among banks, non-banking finance companies, and lending service providers (LSPs, popularly known as fintech players) in the digital lending space.

Background:
 DLG is also known as First Loss Default Guarantee (FLDG). The RBI nod for compensating banks in case of default is expected to boost fintech activity in the financial sector. (Entry of small and medium fintech companies)

What is FLDG?
 It is an arrangement whereby a third party such as a financial technology (fintech) player (LSP) compensates lenders if the borrower defaults.
 For all practical purposes, credit risk is borne by the LSP without having to maintain any regulatory capital.

What were RBI’s concerns earlier?
 RBI had expressed reservations about the FLDG arrangement because it felt that the model could pose a systemic risk.
 The RBI guidelines (2022) on digital lending did not provide clarity on the FLDG structure.

What are the new guidelines?
 The RBI permitted FLDG arrangements between banks and fintech or between two REs.
 The LSP-providing DLG must be incorporated as a company under the Companies Act, 2013.
 Banks and NBFCs should ensure that the total amount of DLG cover on any outstanding portfolio does not exceed 5% of the amount of that loan portfolio.