On Thursday, the Reserve Bank of India (RBI) brought back First Loss Default Guarantee (FLDG). According to RBI’s notification, the central bank has proposed this regulatory framework to permit default loss guarantee arrangements for digital lenders.

What is FLDG?

First loss default guarantee (FLDG) is a lending model between fintech firms and their partner banks and non-banking finance companies where the initial hit on a default is taken by the fintech firm that originated the loan.
Under this, the fintech originates a loan and promises to compensate the partners up to a pre-decided percentage in case customers fail to repay.

Primarily, this arrangement was seen as a tool to expand the customer base of traditional lenders but relies on the fintechs underwriting capabilities.
FLDG is also seen as a validation of the fintechs underwriting capabilities for loans disbursed.

RBI’s stance

In guidelines issued in 2022, the RBI had indicated it was not in favour of such arrangements since they could encourage lenders to take on undue risk.

However, the proposed regulatory framework is “in tune with our objective of maintaining a balance between innovation and prudent risk management,” the RBI said in the Statement on Developmental and Regulatory Policies.

The move comes after extensive consultations with various stakeholders and detailed guidelines will follow, the RBI said.

Separately, the RBI also proposed to issue a “comprehensive” regulatory framework governing compromise settlements and technical write-offs for all its regulated entities.

This framework, the central bank said, will also rationalise the existing prudential norms to implement resolution plans in respect of exposures affected by natural calamities.

Fintech’s view

According to Anil Pinapala, Founder & CEO, Flexpay by Vivifi, the recent announcement by RBI to establish a framework and regulations for facilitating Foreign Lending and Debt Guarantees (FLDG) is a commendable step.

“This will significantly contribute to the expansion of the Digital Lending industry. Many Digital Lending companies encounter difficulties in securing local debt capital and managing liability issues. The introduction of FLDG not only encourages banks to offer liquidity but also enables them to effectively mitigate risks through FLDG protection. This development will undoubtedly enhance the collaboration between banks and fintech/digital lending firms, bolstering their partnerships and overall stability,” he said.