In an attempt to regulate the ever-increasing number of digital lending credit products and services offered via creative dual structures, RBI issued the digital lending guidelines[1] in September 2022 ("Guidelines"). The Guidelines delved on the relationship between regulated entities like banks and NBFCs (“RE”) which would ideally be the lender and other fintech companies assisting such REs in the provision of their credit products and services to end consumers. As per the Guidelines, such a fintech company fell under the definition of "Lending Service Provider" or “LSP” which would include any agent of the RE that carries out one or more of the lender's functions like customer acquisition, giving underwriting support, KYC, recovery of loan and so on.
While the Guidelines had clarified the LSP's obligations with respect to the provision of the credit product to the end consumer, including without limitation, obligations with respect to transparency, there wasn’t much clarity on the risk-sharing mechanism commonly adopted by most LSPs by providing underwriting in the form of first loss default guarantee or FLDG.
On June 08, 2023, RBI has released clarificatory guidelines[2] ("New Guidelines") with respect to such underwriting commonly provided by LSPs which may be either by way of cash deposits to the RE, fixed deposit maintained with a scheduled commercial bank with a lien marked in favour of the RE or by way of bank guarantee (collectively called ‘Guarantee’).
While RBI has finally clarified the mechanism of the Guarantee, it puts a very low limit on the same. The New Guidelines state that the Guarantee cannot exceed 5% (five percent) of the outstanding loan portfolio amount.
The New Guidelines further add the following obligations:
1. Timeline for invocation - Guarantee is to be invoked within a maximum overdue period of 120 (one hundred and twenty days);
2. Tenure - Guarantee tenure to be as long as the loan with the longest tenure in the portfolio; and
3. Disclosure - LSP to undertake to publish on its website, the total number of portfolios and the respective amount of each portfolio on which the Guarantee has been offered.
While the New Guidelines have come as a relief to the fintech sector, providing much-needed clarity on the subject of FLDG in digital lending; the mechanism will require the LSPs to accordingly restructure their arrangements with REs to ensure compliance with the same.