RBI Guidelines on Default Loss Guarantee

June 9, 2023

The Reserve Bank of India (RBI) has taken a significant step by allowing a ‘first loss default guarantee’ (FLDG) arrangement between regulated entities and lending service providers. This move aims to enhance the digital lending sector and mitigate credit risks associated with it.

Understanding Synthetic Securitisation

Synthetic securitisation is a structure used to transfer credit risk in part or whole through credit derivatives or guarantees. It involves hedging the credit risk of an underlying pool of exposures, while the lender retains the portfolio on its balance sheet.

Default Loss Guarantee Arrangements

Regulated entities, such as banks and NBFCs, can now enter into default loss guarantee (DLG) arrangements with lending service providers or other regulated entities. These arrangements offer a credit-risk sharing agreement where a third party guarantees to compensate up to a certain percentage of default in the loan portfolio of the regulated entity.

Forms of Default Loss Guarantees

The guidelines issued by the RBI specify various forms of default loss guarantees allowed for regulated entities. These include cash deposits with such entities, fixed deposits maintained with a lien marked in favor of the entity, and bank guarantees in favor of the entity.

Key Requirements and Responsibilities

Regulated entities must ensure that the total amount of default loss guarantee cover on any outstanding loan portfolio does not exceed five percent of that portfolio. It is the responsibility of the regulated entity to recognize individual loan assets in the portfolio as non-performing assets and make the necessary provisions accordingly.

Furthermore, 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 act as a substitute for credit appraisal requirements. Robust credit underwriting standards must be maintained irrespective of the guarantee cover.

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