RBI Guidelines on Default Loss Guarantee | Current affairs today | Default Loss Guarantee (DLG) Arrangements
Revolutionizing Digital Lending: The First Loss Default Guarantee (FLDG) Arrangement
Introduction
The Reserve Bank of India (RBI) has taken a monumental step forward with the introduction of a groundbreaking measure called the "first loss default guarantee" (FLDG) arrangement. This innovative initiative aims to strengthen the digital lending sector while effectively managing the associated credit risks.
Understanding Synthetic Securitisation: Transferring Credit Risks
Synthetic securitisation is an advanced framework used to transfer credit risks, whether partially or entirely, through credit derivatives or guarantees. It involves mitigating the credit risk of an underlying pool of exposures while the lender retains the portfolio on its balance sheet.
Default Loss Guarantee (DLG) Arrangements: Mitigating Credit Risks
Regulated entities, including banks and NBFCs, now have the opportunity to engage in default loss guarantee (DLG) arrangements with lending service providers or other regulated entities. These arrangements establish a credit-risk sharing agreement in which a third party guarantees compensation for a specified percentage of defaults in the regulated entity's loan portfolio.
Various Forms of Default Loss Guarantees
The RBI's guidelines outline several permissible forms of default loss guarantees for regulated entities. These include cash deposits with such entities, fixed deposits held with a lien marked in favor of the entity, and bank guarantees favoring the entity.
Key Requirements and Responsibilities
Regulated entities have a crucial responsibility to ensure that the total amount of default loss guarantee coverage on any outstanding loan portfolio does not exceed five percent of the portfolio's value. It is the duty of the regulated entity to identify individual loan assets in the portfolio as non-performing assets and make the necessary provisions accordingly.
Additionally, the RBI has directed regulated entities to establish a board-approved policy before entering into any DLG arrangement. It is important to note that the DLG arrangement cannot substitute credit appraisal requirements. Robust credit underwriting standards must be maintained, regardless of the guarantee coverage.
Enhancing Digital Lending with FLDG Arrangement
The introduction of the first loss default guarantee (FLDG) arrangement by the Reserve Bank of India marks a significant milestone for the digital lending sector. By enabling regulated entities to engage in default loss guarantee (DLG) arrangements, this measure enhances the overall stability and resilience of the lending ecosystem.
Benefits of FLDG Arrangement
The FLDG arrangement offers numerous benefits to the digital lending landscape. First and foremost, it provides a mechanism for sharing credit risks, reducing the potential negative impact on individual lenders. This promotes a more secure and sustainable lending environment, attracting greater participation from lenders and fostering healthy competition.
Moreover, the FLDG arrangement encourages financial institutions to adopt prudent lending practices by maintaining robust credit underwriting standards. Lenders are incentivized to conduct thorough due diligence on borrowers, ensuring that creditworthiness is carefully assessed and default risks are minimized.
Protecting Investors and Promoting Financial Inclusion
The FLDG arrangement also plays a vital role in safeguarding the interests of investors. By mitigating credit risks through a third-party guarantee, investors can have increased confidence in the digital lending sector. This, in turn, promotes investment inflows and stimulates growth, creating a favorable environment for borrowers and lenders alike.
Furthermore, the FLDG arrangement contributes to the goal of financial inclusion. By providing a reliable mechanism to manage credit risks, it encourages lenders to extend loans to underserved segments of society, such as small businesses and individuals with limited access to traditional banking services. This promotes economic growth and empowers marginalized communities, fostering a more inclusive and equitable financial landscape.
Conclusion
The Reserve Bank of India's introduction of the first loss default guarantee (FLDG) arrangement is a transformative step towards revolutionizing the digital lending
