As an update, the Reserve Bank of India ("RBI") has notified the attached 'Guidelines on Default Loss Guarantee in Digital Lending' ("DLG Guidelines") on June 8, 2023 (with effect from the date of the notification), which is a much-awaited development post the restrictions imposed on first loss default guarantee (FLDG) arrangements between entities undertaking digital lending as stipulated under the Guidelines on Digital Lending dated 2 September 2022 ("Digital Lending Guidelines"). The DLG Guidelines are applicable to arrangements between Regulated Entities ("Res") and Lending Service Providers ("LSPs") or between two REs involving DLG. The definition of RE's and LSPs is as set out in the Digital Lending Guidelines.
The Digital Lending Guidelines stipulated that all FLDG arrangements must comply with rules prescribed for synthetic securitisation, thereby implying that FLDG arrangements were completely prohibited. As a positive development, the RBI has modified its stance and clarified that the Default Loss Guarantee (DLG) arrangements falling under its ambit cannot be treated as 'synthetic securitisation' and/ or shall also not attract the provisions of 'loan participation'. FLDG arrangements have now been permitted under the DLG Guidelines and are subject to certain conditions such as, inter alia,
Structure of DLG arrangements: Arrangements in respect of DLG are to be backed by legally enforceable contracts between a RE and LSP which must, inter alia, cover (i) the extent of DLG cover; (ii) the form of DLG cover to be maintained with the RE; (iii) the timeline for invocation of DLG (which is currently stipulated as 120 days overdue payments); and (iv) disclosure requirements including publication (on the RE and LSP websites) of the total number of portfolios with the amount of each portfolio on which DLG has been offered;
Forms of DLG Acceptance: DLG may be accepted by the RE's only in certain forms, such as: (i) cash deposits with the RE; (ii) fixed deposits maintained with a Scheduled Commercial Bank with a lien marked in the RE's favor; or (iii) bank guarantee in the RE's favor.
Cap of DLG Cover: Total amount of DLG cover on any outstanding portfolio, specified upfront, cannot exceed 5% of the amount of the loan portfolio in question. This condition also extends to implicit guarantee arrangements (such as performance indemnities for collections and recoveries), and the DLG provider's performance risk cannot exceed 5% of the underlying loan portfolio;
Recognition of NPA: RE shall be responsible for recognition of individual loan assets as NPA and the consequent provisioning as per the extant asset classification and provisioning norms irrespective of DLG cover available at the portfolio level; and
Tenor of DLG Agreement: The period for which the DLG agreement will remain in force shall not be less than the longest tenor of the loan in the underlying loan portfolio,
as set out in the DLG Guidelines.
It is pertinent to note that the following arrangements and entities are excluded from the ambit of DLG Guidelines:
- Guarantee schemes of Credit Guarantee Fund Trust for Micro and
Small Enterprises (CGTMSE), Credit Risk Guarantee Fund Trust for
Low Income Housing (CRGFTLIH) and individual schemes under National
Credit Guarantee Trustee Company Ltd (NCGTC).
- Credit guarantee provided by Bank for International Settlements, International Monetary Fund, as well as Multilateral Development Banks as referred to in Paragraph 5.5 of RBI Master Circular on Basel III Capital Regulation dated 12 May 2023.
Please find attached a copy of the DLG Guidelines.
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.