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RBI permits ‘loan default guarantee’ in digital lending

  • Category
    Economy
  • Published
    17th Jun, 2023

Context

The Reserve Bank of India (RBI) has allowed default loss guarantee (DLG), a safety-net arrangement among banks, non-banking finance companies, and lending service providers (LSPs) in the digital lending space.

  • DLG is also known as ‘First Loss Default Guarantee (FLDG)’.

Who are lending service providers (LSP)?

  • Lending service providers are new-age players who use technology platforms in the lending space.
  • They are agents of a bank or NBFC who carry out one or more of a lender’s functions (in part or full) in customer acquisition, underwriting support, pricing support, disbursement, servicing, monitoring, recovery of specific loan or loan portfolio on behalf of REs .

First Loss Default Guarantee (FLDG):

  • FLDG is an arrangement whereby a third party such as a financial technology (fintech) player (LSP) compensates lenders if the borrower defaults.
  • The LSP provides certain credit enhancement features such as first loss guarantee up to a pre-decided percentage of loans generated by it.
  • Offering FLDG acts to investors will work as a demonstration of its underwriting skills.
  • From the perspective of the lender, it ensures the platform’s skin in the business.

About RBI’s move:

  • The RBI, after examining FLDG, permitted the arrangements between banks and fintechs or between two regulated entities (REs).
  • The central bank said an RE can enter into DLG arrangements only with an LSP or other REs with which it has entered into an outsourcing (LSP) arrangement.
  • The LSP-providing DLG must be incorporated as a company under the Companies Act, 2013.
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