- The Reserve Bank of India (RBI) has released guidelines on Default Loss Guarantee ("DLG") in digital lending dated June 08, 2023 ("Guidelines"), allowing arrangements between Regulated Entities ("RE") and Lending Service Providers ("LSPs") or between two RE's.
- DLG arrangements complying with the Guidelines shall not be categorized as synthetic securitization as defined under para 5(y) of the Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021 dated September 24, 2021 or subject to loan participation provisions as defined under Para 9(e) of the Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 dated September 24, 2021.
- The Guidelines shall apply to Commercial Banks (including Small Finance Banks), Primary (Urban) Co-operative Banks, State Co-operative Banks, Central Co-operative Banks, and Non-Banking Financial Companies (including Housing Finance Companies).
- Under the Guidelines, DLG is defined as a contractual agreement where a provider guarantees compensation to the RE for losses resulting from defaults, up to a specific percentage of the loan portfolio. This definition also includes any other upfront explicit guarantee linked to the loan portfolio's performance (DLG shall not involve any actual transfer of the underlying loan exposure from the books of the RE to the books of the DLG provider).
- The DLG provider must be a company incorporated under the Companies Act, 2013.
- The DLG arrangements should have a legally enforceable contract specifying the extent of DLG cover, the form in which DLG cover is maintained, the timeline for invocation, and disclosure requirements.
- Forms of DLG shall include (i) cash deposited with the RE, (ii) fixed deposits with a Scheduled Commercial Bank with a lien in favor of the RE, or (iii) a bank guarantee in favor of the RE.
- The total DLG cover on any outstanding portfolio should not exceed 5% of the loan portfolio's amount. For implicit guarantee arrangements, the DLG provider should not bear performance risk exceeding 5% of the underlying loan portfolio.
- The responsibility for recognizing individual loan assets as non-performing assets (NPAs) and provisioning remains with the RE, regardless of DLG cover. The amount of DLG invoked cannot be set off against the underlying individual loans, but recoveries from such loans can be shared with the DLG provider as per the contractual arrangement.
- DLG does not impact the regulatory capital computation, exposure computation, or application of credit risk mitigation benefits, which continue to be governed by existing norms.
- DLG should be invoked by the RE within a maximum overdue period of 120 days unless the borrower settles the same.
- The DLG agreement should remain in force for a period not less than the longest tenor of the loans in the underlying loan portfolio.
- The RE should establish a mechanism to ensure that LSPs with DLG arrangements publish on their websites the total number of portfolios and the respective amounts covered by DLG.
- Before entering into any DLG arrangement, the REs should have a Board-approved policy specifying the eligibility criteria for DLG providers, the nature and extent of DLG cover, monitoring and review processes, and details of fees, if applicable.
- DLG arrangements shall not act as a substitute for credit appraisal requirements, and robust credit underwriting standards should be maintained irrespective of DLG cover.
- Every time an RE enters into or renews a DLG arrangement, it should obtain adequate information to verify the DLG provider's ability to honour the arrangement. This information should include a declaration from the DLG provider, certified by the statutory auditor, stating the aggregate DLG amount outstanding, the number of REs, the number of portfolios covered by DLG, and past default rates on similar portfolios.
- Customer protection measures and grievance redressal for DLG arrangements should follow the guidelines outlined in the RBI's "Guidelines on Digital Lending" dated September 02, 2022 along with other applicable norms.
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.
