RBI Guidelines on First Loss Default Guarantee: A Credit Line for Fintech Players
The Reserve Bank of India (RBI) had constituted a working group in January 2021 to study all aspects of digital lending activities by regulated and unregulated entities/players in the financial sector with an aim to regulate the digital lending in India. The working group submitted its report on digital lending to the RBI in November 2021 and provided its recommendations and suggestions with a view to enhance the customer protection and make the digital lending ecosystem safe and sound. While various recommendations of the working group had been accepted and considered by the RBI in the Digital Lending Guidelines (Guidelines) issued on 2 September 2022, some of recommendations required further examination by RBI.
With respect to the credit sharing arrangement involving first loss default guarantee (FLDG) between the lenders and the lending service providers (LSPs), the working group had expressed its concerns stating that such a synthetic structure enables the unregulated entities to lend without complying with prudential norms and other criteria specified for the lenders since the loan portfolio backed by FLDG is akin to off-balance sheet portfolio of the LSP. Therefore, the working group had recommended that in order to prevent loan origination by unregulated entities, the lenders should not be allowed to enter into any synthetic structure such as FLDG. The recommendation pertaining to FLDG was accepted (in-principle) by the RBI subject to further examination. In the Guidelines, the RBI advised the lenders to adhere to the provisions on synthetic securitisation(1) set out in the SSA Directions(2). These directions do not permit the lenders to undertake synthetic securitisation, they only permit the securitization of exposures purchased from other lenders. Further, pursuant to the RBI directions on transfer of loan exposure (Loan Transfer Directions),(3) a contractual arrangement involving loan participation(4) (i.e., transfer of economic interest(5)) cannot be entered into by the lenders unless the transferee is a scheduled commercial bank or small financial bank or a NBFC.
