Regulatory Developments In The Digital Lending Space

Clarifications on Default Loss Guarantee

On April 26, 2024, the Reserve Bank of India (RBI) issued certain Frequently Asked Questions (FAQs) providing clarifications in relation to Guidelines on Default Loss Guarantee in Digital Lending (DLG Guidelines).

Under the DLG Guidelines, issued on June 08, 2023, the RBI permitted Regulated Entities (REs) to enter into arrangements with third parties, including Lending Service Providers (LSPs) for default loss guarantee (DLG), which is also known as first loss default guarantee (FLDG) in the industry. In a DLG arrangement, such third-party guarantees to the RE loss arising due to default of repayment by borrower (DLG Provider).

The key takeaways of the FAQs are as under:

• Cap on DLG: The DLG Guidelines permit REs to effectuate a DLG arrangement with a DLG Provider for loss up to a cap of 5% of the total loan portfolio specified upfront (DLG Cover), where the loan portfolio must be determined before disbursement of the loan. The FAQs, amongst other things, clarify the manner of computation of the DLG Cover.

• Measuring the DLG Cover:

The RE's loan portfolio over which DLG Cover can be offered must consist of loan assets that are identified and measured out of the loans sanctioned by the RE, which will remain fixed at all times (DLG Set). In terms of the FAQs, the DLG Cover will be calculated based on the value of RE's loan assets that comprise the DLG Set. However, such DLG Cover will be dependent on the actual amount disbursed by the RE, out of such DLG Set (which is based on the loans that are sanctioned by the RE).

The DLG Set will not be affected or altered by the loan repayments or write-offs in relation to the loans. From the FAQs, it appears that the RE is at liberty to determine the DLG Sets and accordingly, could have multiple DLG Sets out of its total loan book.

An example to understand the computation of the DLG Cover is provided below:

• Invocation of DLG Cover:

Once DLG is invoked due to a default, the amount of the DLG Cover cannot be reinstated, even in case of subsequent recovery from the borrower. Hence, in the above example, the invocation is discussed in the below table:

The below table depicts the status of the DLG after the end of Month 4:

* The balance DLG Cover available with the RE is not affected by recovery of default amount from the borrowers (during Month 3).

• The DLG arrangement is not permitted for loans arranged on NBFC-P2P platforms as well as credit cards.

These FAQs provide much awaited clarifications on computation of DLG.

Draft Guidelines for Aggregation of Loan Products from multiple REs

The RBI has issued draft guidelines on 'Digital Lending – Transparency in Aggregation of Loan Products from Multiple Lenders' vide its press release dated April 26, 2024 (Draft Circular). The Draft Circular is primarily intended to address scenarios where an LSP offers aggregation of loan products offered by multiple REs and the borrower is matched to one of these REs. In the Draft Circular, the RBI has observed that the identity of the potential RE may not be known to the borrower upfront.

With the objective of customer centricity and to ensure complete transparency for borrowers in the credit intermediation process, the Draft Circular proposes the following measures:

• LSP must display all loan offers that are available based on the borrower's requirements, from all the willing REs.

• In relation to the above, the LSP must publish: (a) names of the RE extending the loan offer, (b) amount of loan, (c) tenor of loan, (d) Annual Percentage Rate (APR), (e) link to the key facts statement (KFS), and (f) other key terms that enable (in any way) borrower to make a fair comparison between various offers.

• LSP must follow a consistent approach to ascertain the willingness of REs to offer a loan, and this must be suitably disclosed on the LSP's website.

• The content displayed by the LSP needs to be unbiased and must not (directly or indirectly) promote or push a product of a particular RE, including by use of any practices or deceptive / dark patterns (as defined by the Central Consumer Protection Authority under the Guidelines for Prevention and Regulation of Dark Patterns, 2023' dated November 30, 2023) designed to mislead borrowers into choosing a particular loan offer.

The RBI has invited comments and feedback on the Draft Circular by May 31, 2024.

RBI Mandates Provision of Key Fact Statement for All Loans & Advances

The RBI has issued a notification, on April 15, 2024, on 'Key Facts Statement for loans and advances' (KFS Notification), pursuant to its earlier announcement under the Statement on Developmental and Regulatory Policies dated February 8, 2024.

The KFS Notification harmonises instructions for the Key Facts Statement (KFS) to enhance transparency and symmetry amongst various financial products offered by the REs, including those offered through digital lending.

The key takeaways of the KFS Notification are as under:

• KFS:

KFS is a statement of legally significant and deterministic facts and information relevant to assist the borrower in taking an informed financial decision, which is provided in a language which is simple and easy to understand. These facts and information are often contained under the loan agreement that RE requires the borrowers to execute.

The KFS Notification stipulates that the RE must not levy any fees or charges not specified in the KFS during the entire tenor, unless the borrower provides explicit consent.

• Timing of KFS: As per the KFS Notification, the RE must provide KFS to the borrowers before the loan agreement is executed, including to prospective borrowers.

• Contents of KFS:

KFS must include basic details about the loan, such as sanctioned loan amount, disbursal schedule, tenor of the loan, interest rate; computation of all charges that the RE levies in the form of the 'Annual Percentage Rate' (APR) computation; the amortisation schedule of the loan; and charges that are payable to third-parties other than the RE when collected their behalf (for instance, charges payable for an insurance cover availed by the borrower).

Also, the REs are required to provide a unique proposal number for the KFS.

In an interesting move, the RBI seems to have clarified that the charges which can be levied on a borrower, including penal charges for delay in repayments, can be levied either as a fixed amount or as a percentage. This is a useful clarification in context of the circular 'Fair Lending Practice - Penal Charges in Loan Accounts' issued by the RBI on August 18, 2023, which is scheduled to come into effect from June 30, 2024.

• Format: The KFS is required to be provided to borrowers in a standardised format, which is provided under the KFS Notification.

• Validity of KFS: The RBI has introduced a concept of a validity period for the KFS, which must be provided to the borrower to make a decision in relation to the loan and agree to the contract. During the said validity period the terms of the loan as set-out in the KFS cannot be altered by the RE. In this regard, for any loan of a tenor of 7 days or more, the KFS must have a validity of 3 working days; and of 1 working day for shorter duration loans.

The RBI has directed the REs to ensure compliance with the prescriptions under the KFS Notification, in letter and spirit and without any exception, for all new loans sanctioned as well as fresh loans to existing customers, from October 1, 2024.

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.