The Reserve Bank of India ("RBI") has recently released comprehensive guidelines on Default Loss Guarantee ("DLG") in Digital Lending. These guidelines aim to establish a framework for arrangements involving DLG, commonly known as First Loss Default Guarantee ("FLDG"), within the digital lending sector. The guidelines provide a structured approach for regulated entities ("REs") to manage risks and protect lenders against default losses.
Under the newly issued guidelines, REs, including Commercial Banks, Small Finance Banks, Primary (Urban) Co-operative Banks, State Co-operative Banks, Central Co-operative Banks, and Non-Banking Financial Companies (including Housing Finance Companies), are permitted to enter into DLG arrangements. These arrangements involve a contractual agreement between the RE and a DLG provider, whereby the provider guarantees compensation to the RE for losses incurred due to default, up to a predetermined percentage of the loan portfolio.
The guidelines outline several important provisions to ensure the effectiveness and transparency of DLG arrangements:
- Eligibility and Forms of DLG: DLG arrangements can be established between an RE and a Lending Service Provider ("LSP") or between two REs with an outsourcing arrangement. The LSP must be incorporated as a company under the Companies Act, 2013. DLG can be accepted in the form of cash deposits, fixed deposits with a lien marked in favor of the RE, or a bank guarantee.
- Cap on DLG: REs must ensure that the total DLG cover on any outstanding portfolio does not exceed five percent of the loan portfolio. Implicit guarantee arrangements should not bear a performance risk of more than five percent of the underlying loan portfolio.
- NPA Recognition: The responsibility for recognizing individual loan assets as Non-Performing Assets ("NPA") and provisioning remains with the RE, regardless of any DLG cover available at the portfolio level. The amount of DLG invoked cannot be set off against the underlying individual loans.
- Disclosure Requirements: LSPs with DLG arrangements must disclose the total number of portfolios and the respective amounts of each portfolio on their website, where DLG has been offered.
- Due Diligence and Customer Protection: REs are required to have a Board-approved policy for DLG arrangements, including eligibility criteria for DLG providers, monitoring and reviewing processes, and details of fees payable to the DLG provider. Customer protection measures and grievance redressal issues should follow the existing guidelines on Digital Lending and other applicable norms.
The introduction of DLG guidelines brings several implications and benefits to the digital lending landscape:
- Risk Management: The guidelines provide a structured framework for managing risks associated with default losses in digital lending. By establishing DLG arrangements, REs can mitigate potential losses and enhance risk management practices.
- Transparency and Accountability: DLG arrangements promote transparency by requiring LSPs to disclose information about the portfolios covered by DLG on their websites. This fosters greater accountability and builds trust among lenders and borrowers.
- Enhanced Customer Protection: The guidelines emphasize the importance of customer protection measures and grievance redressal mechanisms. This ensures that borrowers' interests are safeguarded and promotes responsible lending practices.
- Strengthened Digital Lending Ecosystem: With the adoption of DLG guidelines, the digital lending ecosystem is expected to grow with increased confidence and resilience. The guidelines provide clarity and regulatory oversight, creating a favorable environment for innovation and expansion in the sector.
The RBI's guidelines on DLG in Digital Lending mark a significant step towards strengthening risk management practices and protecting lenders in the evolving digital lending landscape. By outlining the eligibility criteria, forms of DLG, disclosure requirements, and customer protection measures, the guidelines promote transparency, accountability, and responsible lending practices. REs and LSPs are encouraged to embrace these guidelines and contribute to the growth and stability of the digital lending ecosystem.
