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Default loss guarantee (DLG)/ First Loss Default Guarantee (FLDG)

Facts for Prelims (FFP)

Source: IE

 Context: The RBI has allowed a Default loss guarantee (DLG) (also called first Loss Default Guarantee (FLDG), a safety-net arrangement among banks, non-banking finance companies (NBFCs) and lending service providers (LSPs).

 

LSPs: These are new-age technology platforms/ agents (of a bank or NBFC) in the lending space who carry out one or more of a lender’s functions on behalf of regulated entities (REs).

 

What is an FLDG arrangement?

  • 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.

 

Previous arrangement:

  • 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.

 

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.

 

Significance: This will facilitate the entry of small and medium fintech into the digital lending space in partnerships with banks or NBFCs.