– By Nirav Choksi
In the past decade, India’s FinTech sector has evolved from niche players to integral solution providers, and now stands at the brink of unprecedented growth in technological advancements and financial inclusion. The Reserve Bank of India’s (RBI’s) recent decision to allow Default Loss Guarantee (DLG) arrangements in digital lending has ushered in a new era of possibilities for the country’s FinTech sector. These guidelines, which provide clarity on lending arrangements between FinTechs, banks, and Non-Banking Financial Companies (NBFCs), are poised to reshape the landscape of the industry.
Deconstructing RBI’s guidelines for FLDG
The release of the First Loss Default Guarantee (FLDG) guidelines marks a significant milestone for India’s FinTechs. It is the first time that the RBI has approved the FLDG program, which enables credit-risk sharing arrangements between FinTechs and regulated lenders like banks and NBFCs. Under the new rules, the RBI gives the green signal to the FLDG scheme, wherein unregulated entities offer guarantees to regulated lenders in the event of borrower defaults.
In this lending arrangement, a percentage of the default loan portfolio of registered entities is guaranteed by FinTechs or Lending Service Providers. FLDGs empower FinTechs to showcase their underwriting capabilities and earn the trust of banks and NBFCs. Previously, FinTechs provided FLDG guarantees of up to 100 per cent to their banking partners, exposing them to high risks and potential losses. In September 2022, the RBI cracked down on such arrangements, restricting FLDGs to only Regulated Entities (REs).
Some of the Key Highlights of the new framework are –
1. A 5 per cent cap on FLDG arrangements, ensuring that the total default guarantee provided by FinTechs does not exceed 5 per cent of the portfolio amount.
2. FLDG arrangements can only be carried out between RBI-regulated entities and LSPs or between two regulated entities that have entered into an outsourcing agreement.
3. REs are allowed to invoke FLDG within a maximum overdue period of 120 days, highlighting the RBI’s commitment to timely default resolution.
4. REs can accept DLGs only if FinTechs provide a hard guarantee in the form of cash deposits, bank guarantees, or fixed deposits maintained with scheduled commercial banks.
5. The RBI instructs LSPs to publish details of the total number of portfolios and respective amounts on which FLDG has been offered on their websites.
6. REs remain responsible for recognizing individual loans in the portfolio as Non-Performing Assets (NPA) and making necessary provisioning, regardless of the FLDG cover at the portfolio level.
How will the new framework impact the FinTech sector?
The new FLDG framework brings much-needed clarity to the relationship between REs and LSPs, offering respite to the FinTech industry. It is expected to have the following significant impacts:
1. Strengthened credit penetration: RBI’s circular on FLDG arrangements propels the digital lending industry, bolstering credit penetration in the country. This growth will also pave the way for innovative FinTech lending models that were previously hindered by ambiguity surrounding FLDG arrangements, gaining greater acceptance among REs.
2. Balanced risk exposure: The reasonable 5 per cent cover allows regulated entities to manage risk effectively and opt out of high-risk lending arrangements, ensuring a more balanced ecosystem.
3. Enhanced partnerships and collaborations: The FLDG scheme facilitates deeper partnerships and collaborations between banks, NBFCs, and new-age FinTechs. REs will need to establish robust frameworks to comply with regulations, fostering growth in partner-led digital lending initiatives.
4. Empowering MSMEs: The FLDG guidelines provide renewed hope for the MSME sector, which faces capital constraints. REs will be more open to extending micro-sized loans, while FinTechs will augment their offerings and deploy robust underwriting platforms, bridging the gap in last-mile credit delivery.
5. Increased transparency: The public availability of LSP-RE agreements is expected to promote transparency within the lending ecosystem, benefiting all stakeholders.
FinTechs at the forefront
According to a recent report by Boston Consulting Group, India’s FinTech sector is projected to witness an extraordinary sixfold increase in revenues, reaching $1.5 trillion by 2030. The new FLDG guidelines present FinTechs with a golden opportunity to innovate and scale up transformative financial products. The well-structured FLDG framework, complete with eligibility criteria, due diligence requirements, disclosure guidelines, and customer protection measures, eliminates previous ambiguities and paves the way for FinTechs to drive financial inclusion. By leveraging these rules, FinTechs can build the necessary infrastructure to bring MSMEs and underserved segments of the economy within the ambit of financial services.
The bottom line
RBI’s new FLDG guidelines serve as a catalyst for FinTech innovation and financial inclusion in India. These guidelines provide clarity, establish boundaries, and create a fertile ground for partnerships, collaboration, and the development of transformative financial products. With the potential for significant growth on the horizon, the future of India’s FinTech sector is bright and promising.
(Nirav Choksi is the co-founder & CEO of CredAble.)
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