Loss Default guarantee norms | RBI gives clarity but some sectors may see near-term impact: CRISIL Ratings

Reserve Bank of India (RBI)

The recent guidelines from the Reserve Bank of India (RBI) on first loss default guarantee (FLDG) offer much-needed clarity in digital lending yet there could be some near-term impact because of the new structure, ratings agency CRISIL said on June 12.

"The guidelines give clarity on digital lending for banks and NBFCs concerning FLDG. Even though there could be a near-term impact on business volume," CRISIL said.

On June 8, the RBI introduced guidelines on FLDG.

Any other implicit guarantee of similar nature linked to the performance of the loan portfolio of the RE (regulated entity) and specified upfront shall also be covered under the definition of DLG," the central bank said.

However, the agency highlighted that the RBI has tightened norms on the extent and form of FLDG cover, and recognition of NPAs in partnership models which include limiting FLDG to 5 percent of the loan portfolio and not allowing corporate guarantees as a form of FLDG.

Ajit Velonie, Senior Director at CRISIL Ratings, highlighted that some existing partnerships where FLDG is present would be affected by the new guidelines.

“We estimate that a substantial proportion of partnership/co-lending arrangements where FLDG is present, especially those with unsecured personal loan and business loan lenders, currently carry an FLDG cover of above 5 percent. These segments would be affected by the new guidelines," Velonie said.

Similarly, Subha Sri Narayanan, Director at CRISIL Ratings said a drop in volumes in segments with relatively higher FLDG is expected.

"We expect the co-lending market to see a drop in volumes in segments with relatively higher FLDG and the market may see sourcing lenders adapting their business models to align with the revised regulations," said Narayanan.

In September 2022, the RBI prohibited regulated entities from entering into FLDG arrangements with unregulated entities. It had said that the loan offered to a consumer is ‘strictly between the lender and the consumer,’ and the fintech partner is just a loan originator, basically like an agent.

Now, the central bank has permitted regulated entities to enter into FLDG arrangements with unregulated entities, subject to a 5 percent cap.

According to the new framework, the default cover could be provided for up to 5 percent of the loan portfolio and shall be invoked within a maximum overdue period of 120 days.