The Reserve Bank of India ("RBI") has framed a comprehensive infrastructure of regulatory stepping stones for default loss guarantee in digital lending through 'Guidelines on Default Loss Guarantee in Digital Lending'1 ("DLG Guidelines") issued on June 8, 2023. It is notable that RBI's digital lending guidelines issued on September 2, 2022, preceded the DLG Guidelines and regularised the outsourcing arrangements entered by Regulated Entities (REs) with a Lending Service Provider ("LSP")/ Digital Lending App ("DLA")2.
At present, the contractual arrangements between REs and LSPs or between two REs involving default loss guarantee (DLG), commonly known as First Loss Default Guarantee ("FLDG") are subject to the DLG Guidelines.
For better understanding, the scope of Default Loss Guarantee ("DLG") has been defined as a contractual arrangement between RE and a third party, including an LSP or any other entity with which it has entered into an outsourcing (LSP) arrangement, incorporated as a company under the Companies Act, 2013. The grains of such arrangement outlines the conceptual basis that such third-party guarantees compensate RE the loss incurred due to default up to a certain percentage of the loan portfolio of the RE, specified upfront, due to default on account of the borrower ("DLG Provider").
To visualise the structural integrities of this arrangement, it is pertinent to understand its construction. Such arrangements are backed by a legally enforceable contract specifically marking the following details –
- Extent of DLG cover;
- Form in which DLG cover is to be maintained with the RE;
- Timeline for DLG invocation; and
- Disclosure requirements as under Para 11 of the DLG Guidelines.
To provide further clarity and precision to the interpretation and application of these regulatory bounds, RBI issued certain Frequently Asked Questions ("FAQs")3 providing clarifications to DLG Guidelines. The critical points of the FAQs are enumerated as follows –
1. Scope of cap and cover –
As per the DLG Guidelines, the total amount of DLG cover on any outstanding portfolio specified upfront cannot exceed five per cent of the amount of that loan portfolio. Additionally, in the case of implicit guarantee arrangements, performance risk of more than the equivalent amount of five per cent of the underlying loan portfolio shall not be borne by the DLG Provider. The FAQs have clarified that, to compute the said cap, the portfolio over which DLG is being offered should consist of identifiable and measurable loan assets thus sanctioned. The portfolio is expected to remain fixed for the purpose of DLG cover. It is not meant to be dynamic, and as a result, the cap is expected to apply to the total amount disbursed out of the DLG set at any given time.
2. Scope of DLG loans –
DLG is not permitted for certain types of loans, including those arranged through NBFC-P2P platforms, credit card loans, or revolving credit facilities offered through digital channels. Furthermore, DLG cannot be applied to loans covered by the credit guarantee schemes administered by the National Credit Guarantee Trustee Company (NCGTC).
3. Operational restrictions –
The FAQs clarify that in case the DLG amount is invoked as a result of default occurring in the current portfolio, the same shall not be reinstated subject to subsequent recoveries made from the borrowers on the defaulted amount. REs providing DLG are also required to deduct the full outstanding amount of the DLG from their capital. Additionally, while the DLG Guidelines specify various disclosure obligations, they do not require the disclosure of the name of the RE providing the DLG. This ensures that only the relevant details of the guarantee are shared with the public and regulatory bodies.
4. Regulatory compliance requirements –
The DLG Guidelines require REs accepting DLG cover to have a Board-approved policy in place. Similarly, REs acting as DLG providers must also establish a Board-approved policy as a prudent precaution. Furthermore, the declaration under Para 12.3 of the DLG Guidelines, which pertains to the DLG provider's compliance, must be certified by the statutory auditor of the DLG provider itself, not by the RE. The DLG Guidelines exclude loans sourced outside the Digital Lending framework, meaning they do not apply to non-digital lending scenarios.
To conclude, the clarifications issued by RBI for DLG Guidelines bring more objectivity to the mechanism of the provisions professed thereunder. These clarifications help ensure consistent application of the rules, minimise ambiguity, and reinforce regulatory compliance, thereby promoting transparency and stability in the digital lending ecosystem.
Footnotes
1. Guidelines on Default Loss Guarantee (DLG) in Digital Lending, dated June 08, 2023, available at: https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=12514&Mode=0
2. Guidelines on Digital Lending, dated September 02, 2022, available at: https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12382&Mode=0
3. Guidelines on Default Loss Guarantee in Digital Lending (Updated as on November 05, 2024), dated November 05, 2024, available at: https://www.rbi.org.in/commonman/English/Scripts/FAQs.aspx?Id=3592
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
