Digital lending norms: Fintech firms seek clarity on RBI's FLDG stance

The Reserve Bank of India’s (RBI’s) stance on first loss default guarantee (FLDG) in the recently-released digital lending norms has put fintech players, who use this model extensively, in a spot of bother.

They are now looking to approach the regulator, through their industry bodies, to seek clarity on this issue.

Last week, the RBI came out with detailed guidelines on digital lending.

It said when it comes to the industry practice of offering financial products involving contractual agreements, such as FLDG, regulated entities must adhere to provisions of the master direction on securitisation of standard assets, especially synthetic securitisation.

RBI has defined synthetic securitisation as a structure where credit risk of an underlying pool of exposures is transferred, in whole or part, through the use of credit derivatives or credit guarantees. These serve to hedge the credit risk of the portfolio, which remains on the balance sheet of the lender.

“If the literal meaning of this para is taken, it would transpire that any form of risk transfer in a pool of loans by any lender, to a third party, is not permitted,” said Vinod Kothari Consultants, in a note.

“On FLDG, the industry at large is confused on what is permissible and what is not. This remains an issue that needs further clarification from the regulator. Earlier, digital lending apps (DLAs) or lending service providers (LSPs), who were not regulated, used to give some sort of FLDG to the regulated entities. Now, the RBI has said that synthetic securitisation is not allowed. This is making it complicated to understand,” said an industry executive.

An FLDG is a lending model wherein a third-party guarantees to compensate up to a certain percentage of default in a loan portfolio of the regulated entity. The third party can be a LSP.

Under this, the LSP provides certain credit enhancement features such as first-loss guarantee up to a pre-decided percentage of loans generated by it.

From the LSP’s perspective, offering FLDG acts as a demonstration of its under-writing skills. From the lender’s perspective, it ensures the platform’s skin in the business.

“The RBI has asked the players to refer to the master directions with better compliance of the norms laid down. It’s a good move since there is no new law but it is asking players to innovate within the guardrails of the existing law and increase compliance. This may perhaps increase the compliance cost for some players, but it will largely protect the good guys,” said Anuj Kacker, co-founder of Freo, & executive committee member of Digital Lenders Association of India.

Last month, RBI came out with a list of recommendations of the working group on digital lending that it had accepted for immediate implementation. However, it had placed the recommendation on FLDG under examination.

The working group, formed in January 2021, had recommended that to prevent loan origination by unregulated entities, regulated entities should not be allowed to extend any arrangement involving a synthetic structure, such as the FLDG, to these entities.

“Regulated entities should not allow their balance sheets to be used by unregulated entities in any form to assume credit risk,” it had said in its report.

“In the current scheme of things, the foremost priority is complying with the regulations. It is difficult to predict the implications, in terms of growth of the fintech sector. Some aspects of the guidelines are already being implemented. The timeline set by the regulator is reasonable enough for transition to full compliance,” said Sugandh Saxena, chief executive officer (CEO), FACE, told Business Standard.