RBI Allows 5% Default Loss Cover For Bank-Fintech Deals

The RBI has allowed banks and other regulated entities to enter into default loss guarantee arrangements, but within limits, in a move aimed at curbing the risk of large slippages in tie-ups between lenders and fintechs.

The Reserve Bank of India said a default cover could be provided for up to 5% of the loan portfolio, according to the guidelines issued by the central bank on Thursday.

A default loss guarantee agreement is signed when an RBI-regulated entity—like a bank or a non-bank financial company—enters into a lending deal with a loan service provider or other regulated entities—like a fintech. A portion of the portfolio is guaranteed by the second party, fintechs in this case, in the event of default. In such deals, typically the first lender provides funds to the second party for on-lending.

"Any other implicit guarantee of similar nature linked to the performance of the loan portfolio of the RE (regulated entity) and specified upfront shall also be covered under the definition of DLG," the RBI said.

Regulated entities in this circular refer to banks, cooperative banks, and non-bank finance companies. A loan service provider is an agent of a regulated entity who carries out one or more of the lender's functions in customer acquisition, underwriting support, pricing support, servicing, monitoring, and recovery of specific loans or loan portfolios on behalf of the lender.

Recognition of individual loan assets in the portfolio as non-performing assets and consequent provisioning shall be the responsibility of the regulated lender as per the extant asset classification and provisioning norms, irrespective of any default loss guarantee cover available at the portfolio level.

In situations where the guarantee is invoked by the regulated lender, the RBI has specified a maximum time period of 120 days from the date of default for such action. The amount of DLG invoked shall not be set off against the underlying individual loans.

The regulated lender must ensure that loan service providers publish the total number of portfolios and the respective amount of each portfolio on which the guarantee arrangement has been offered on their website.

These norms will not apply to guarantee arrangements under the Credit Guarantee Fund Trust for micro and small enterprises, the Credit Risk Guarantee Fund Trust for Low Income Housing, or individual schemes under the National Credit Guarantee Trustee Company Ltd.

The guidelines come after the RBI specified in September 2022 that banks and NBFCs must abide by securitisation norms before entering into any guarantee arrangements.

The first loss default guarantee system, which was common between banks and digital lenders, was akin to synthetic securitisation arrangements, which the RBI prohibits. This had led to a virtual freeze on such deals after the regulator's announcement.

The RBI has been engaging with multiple stakeholders, such as the Digital Lenders Association of India, on the DLG and has incorporated most of the feedback into consideration, according to Jatinder Handoo, chief executive officer of DLAI.

"One of the key asks from most sector players has been to provide clarity on the permissible structure for the DLG arrangements between two parties," Handoo said. "The circular issued today clearly specifies details on scope, eligibility, structure, form, cap, disclosure requirements, and exceptions."

This leaves limited room for ambiguity, Handoo said. "We consider this as a step forward for the digital lending industry."

A well-defined structure will facilitate all players participation in an effective and transparent manner and make the best use of the DLG facility, according to the DLAI CEO.