First Loss Default Guarantee(FLDG) system: Digital lending – No clarity, awaiting RBI response, say bank & fintechs

Source: The post is based on the article “Digital lending: No clarity, awaiting RBI response, say bank & fintechs” published in Indian Express on 5th December 2022

What is the News?

Two months after the Reserve Bank issued guidelines on digital lending, banks, non-banking financial companies and fintech players are still awaiting clarity on many aspects including the First Loss Default Guarantee(FLDG) system.

What is the First Loss Default Guarantee(FLDG) system?

FLDG is a lending model between a fintech and a regulated entity in which a third party guarantees to compensate up to a certain percentage of default in a loan portfolio of the regulated entities(RE).

Under these agreements, the fintech originates a loan and promises to compensate the partners up to a pre-decided percentage in case customers fail to repay.

The bank/NBFC partners lend through fintech but from their own books. FLDG helps expand the customer base of traditional lenders but relies on the fintech’s underwriting capabilities.

What are the concerns related to FLDG?

In the report by the RBI-constituted working group on digital lending, the group laid down the risks of FLDG agreements with unregulated entities. The other concern is that FLDG costs are often passed on to customers.