How RBI’s New FLDG Guidelines Broaden The Horizons Of Fintech Innovations

In the last decade, fintechs in India have grown from niche players to mainstream solution providers. The fintech industry in the country is now on the brink of another significant opportunity to scale up new advances in technologies and speed up financial inclusion.

The Reserve Bank of India’s (RBI’s) recent decision to allow Default Loss Guarantee (DLG) arrangements in digital lending comes as a welcomed move for India’s fintech sector. The default loss guarantee guidelines released by the RBI are a boon to the fintechs that have been waiting for more clarity on their lending arrangements with banks and Non-Banking Financial Companies (NBFCs). We will break down the new rules and analyse their impact on India’s booming FinTech sector.

Deconstructing RBI’s Guidelines For FLDG

The First Loss Default Guarantee (FLDG) guidelines released by the RBI have created a watershed moment for fintechs in the country. This is the first time the RBI has approved the FLDG programme, a credit-risk sharing arrangement that fintechs in India use to form partnerships with banks and NBFCs.

According to the new rules, the RBI has given a green signal to the FLDG scheme, a guarantee that an unregulated entity offers to regulated lenders if the borrower defaults. In this lending arrangement, a certain percentage of the default loan portfolio of registered entities such as banks and NBFCs is guaranteed by a third party such as a fintech or a Lending Service Provider (LSP). 

FLDGs allow fintechs to showcase their prowess in underwriting and gain the trust of banks and NBFCs. Previously, the FLDG guarantee provided by fintechs to their banking partners had even gone up to 100%. Such arrangements expose the banks and NBFCs to high risks and exorbitant losses. Especially in cases where the borrower defaults and the fintech is unable to compensate as agreed. In September 2022, the RBI cracked down on such arrangements, permitting FLDGs only between Regulated Entities (REs).

A few of the key highlights of the new framework include:

• The RBI has introduced a 5% cap on the FLDG arrangement. This means that the total default guarantee provided by fintechs to their lending partners shall not exceed 5% of the portfolio amount
• The FLDG arrangement can only be carried out between an RBI-regulated entity and an LSP or between two regulated entities that have entered into an outsourcing agreement
• As per the new rules, the RBI shows that it is committed to the timely resolution of defaults. The RE is allowed to invoke FLDG within a maximum overdue period of 120 days
• The RBI permits REs to accept DLG only if the fintechs provide a hard guarantee in the form of cash deposited with the entities, a bank guarantee in favour of the lender, or fixed deposits maintained with a scheduled commercial bank with a lien marked in favour of the lender
• The RBI has directed the LSPs to publish on their websites the total number of portfolios as well as the amount of each portfolio on which the FLDG has been offered
• The framework also shares that REs are responsible for recognising individual loans in the portfolio as NPA as well as its consequent provisioning, irrespective of the FLDG cover at the portfolio level

What Does This Mean For The Fintech Sector In India?

Previously, in the absence of clear directions from the RBI, regulated entities like banks had reservations about entering into FLDG arrangements with fintechs. The new FLDG framework comes as a breather for the fintech industry and provides clarity on the relationship between REs and LSPs.

The new guidelines are expected to give a well-deserved boost to the fintech industry. We can expect to see some sudden improvements, such as:

• RBI’s circular around the FLDG arrangement is a step forward for the digital lending industry and is bound to strengthen credit penetration in the country. While funding in digital lending fintechs will grow, we will also see innovative fintech lending models—that were put on hold due to lack of clarity on FLDG arrangements find greater acceptance among REs
• The 5% cover is reasonable, allowing regulated entities who are not willing to take on high risk to opt out of this arrangement
• The FLDG scheme also paves the path for deeper partnerships and innovative collaborations between banks, NBFCs, and new-age fintechs. The regulated entities will need to establish proper frameworks to adhere to these compliances and, in turn, grow their partner-led digital lending initiatives
• For the MSME sector that is constantly limited by capital constraints—these new FLDG guidelines bring renewed hope. The REs will be more open to the inclusive provision of micro-sized loans. Fintechs, on the other hand, will be quick to augment their offerings and roll out robust underwriting platforms that will plug the last-mile credit delivery gaps
• As LSP-RE agreements are made available to the public, we will likely see increased transparency within the lending ecosystem

Fintechs In The Spotlight

A recent report from Boston Consulting Group reveals that revenues from the fintech sector are expected to grow sixfold to reach $1.5 Tn by 2030.

The new FLDG guidelines provide fintechs in the country with a golden opportunity to innovate and scale up a suite of transformative financial products. The FLDG framework is well structured, with details on eligibility, due diligence, disclosure requirements and customer protection measures, removing any form of ambiguity that was previously there.

With these new rules, fintechs are perfectly poised to build the infrastructure needed to drive financial inclusion and bring MSMEs and underserved segments of the economy under the ambit of financial services.