The Reserve Bank of India (RBI) has implemented new guidelines allowing banks and other regulated entities to enter into default loss guarantee arrangements with fintech companies, but with certain limitations. This move aims to mitigate the risk of significant defaults in partnerships between lenders and fintechs.
According to the guidelines issued by the central bank on Thursday, a default cover of up to 5% of the loan portfolio can be provided. A default loss guarantee agreement is typically signed when an RBI-regulated entity, such as a bank or non-banking financial company (NBFC), engages in a lending agreement with a loan service provider or other regulated entities like fintechs. In such arrangements, a portion of the portfolio is guaranteed by the second party, in this case, fintech companies, in the event of default. Typically, the first lender provides funds to the second party for on-lending purposes.
The RBI clarified that any implicit guarantee associated with the loan portfolio’s performance by the regulated entity, specified upfront, would also be covered under the definition of default loss guarantee. Regulated entities in this circular refer to banks, cooperative banks, and NBFCs.
The responsibility for recognizing individual loan assets as non-performing assets and making provisions lies with the regulated lender, regardless of the availability of default loss guarantee cover at the portfolio level, as per the existing asset classification and provisioning norms.
In cases 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 taking necessary action. The amount of the invoked default loss guarantee cannot be set off against the underlying individual loans.
To ensure transparency, regulated lenders must ensure that loan service providers publish the total number of portfolios and their respective guaranteed amounts on their websites.
These guidelines do 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.
These regulations follow the RBI’s previous directive in September 2022, which mandated that banks and NBFCs must comply with securitization norms before entering into any guarantee arrangements. The aim is to prevent the use of first loss default guarantee systems, similar to synthetic securitization arrangements, which the RBI prohibits. This announcement had resulted in a temporary halt in such deals.
Jatinder Handoo, CEO of the Digital Lenders Association of India (DLAI), stated that the RBI has incorporated most of the feedback received from stakeholders, including the DLAI, in formulating these guidelines. The clarity provided on the permissible structure for default loss arrangements addresses a key request from sector players. Handoo sees this circular as a positive step forward for the digital lending industry, offering a well-defined structure that promotes effective participation and transparency among all stakeholders.
These guidelines are expected to create a conducive environment for bank-fintech collaborations, allowing lenders and fintechs to leverage the default loss facility in a secure and transparent manner.