FLDG guidelines: Digital lending industry seeks increase in default cover

Several players say default cover of up to 5% of loan portfolio may not be enough when compared to 100% offered by companies to banking partners earlier

The default cover for up to 5 per cent of the loan portfolio under the FLDG (first loan default guarantee) framework could be inadequate, according to a few fintech players, which otherwise welcomed the Reserve Bank of India’s (RBI’s) recent guidelines permitting the use of FLDG arrangements in digital lending.  Earlier, some entities were offering almost 100 per cent FLDG to banking partners.

“It is a good first move. But they (RBI) have still limited it (default cover) to 5 per cent, which in my view is less. I think FLDG has to be more.  I agree with them (RBI) that it cannot be 100 per cent. In an ideal condition, it should become 50 per cent. This will help fintech companies and MSMEs to get access to credit,” said Rohit Arora, CEO and co-founder, Biz2Credit, an online financing platform for small businesses.  

Through the FLDG model, fintech players and banks or non-banking financial companies (NBFCs) used to enter into arrangements through which the former provided a guarantee to compensate for up to a certain percentage of default in a loan portfolio, in some cases it went up to as high as 100 per cent.  Banks were keen on this model because fintech companies were sharing part of the risk.

However, the RBI was not comfortable with the model as fintech firms are not regulated entities under the central bank. “This obviously was not good as lenders were approving everything. Despite the guarantee, they still have the duty to do the right kind of underwriting and manage the risk well,” Arora said.  

Based on the new regulation, the default cover could be provided for up to 5 per cent of the loan portfolio and shall be invoked within a maximum overdue period of 120 days. In addition to this, fintech players will have to submit a guarantee in the form of cash deposit, fixed deposit, or bank guarantee in favour of the lender.  According to the new guidelines, only an RBI-regulated entity is entitled to have an FLDG agreement with a lending service provider or other regulated entities. Another senior executive of a company from the sector batted for an increase in the 5 per cent cap, terming the RBI's move "a good beginning".

“Because fintech firms are not directly regulated by the RBI, and hence they do not get a sense of exposure from the fintech side about NPAs. Now by ensuring there is a 5 per cent limit, you can restrict NPAs. This makes it a win-win combination,” said Praveen Khanna, vice-president alliances, ScoreMe Solutions.

The Fintech Convergence Council (FCC), an industry body for regulated financial service providers and fintech companies, welcomed the RBI move. “One key aspect of the FLDG is the emphasis on increased transparency within the lending ecosystem. Lending service providers (LSPs) will now be required to disclose all their relationships and portfolios, including any default, to relevant entities (REs). This heightened transparency will foster greater trust among stakeholders and enhance accountability within the industry. While the guidelines may expose LSP-RE agreements to scrutiny by competitors, we believe that this will encourage healthy competition and drive further improvements in the lending sector,” it said in a statement.

What is FLDG?

Through the FLDG model, fintech players and banks or non-banking financial companies (NBFCs) used to enter into arrangements through which the former provided a guarantee to compensate for up to a certain percentage of default in a loan portfolio, in some cases it went up to as high as 100 per cent. 

HIGHLIGHTS OF THE NEW GUIDELINES

1. Regulated entity or the lender shall ensure that the total amount of DLG cover on any outstanding portfolio which is specified upfront shall not exceed 5 per cent of the amount of that loan portfolio.

2.  Fintech players will have to submit a guarantee in the form of cash deposit, fixed deposit, or bank guarantee in favour of the lender. 

3. Recognition of individual loan assets in the portfolio as NPA and consequent provisioning shall be the responsibility of the RE as per the extant asset classification and provisioning norms irrespective of any cover available at the portfolio level.