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

The First Loss Default Guarantee (FLDG) is a risk-sharing mechanism where a fintech Lending Service Provider (LSP) agrees to cover up to 5% of losses on a fixed pool of loans it sources for a regulated lender, such as a bank or NBFC. Formalized by RBI guidelines in June 2023, FLDG arrangements must be backed by legally enforceable contracts, apply only to static (non-rolling) loan portfolios, and require invocation within 120 days of default. The framework aims to encourage lending to underserved segments while capping risk exposure for regulated entities.

Key Features and Mechanism

• Structure: Under FLDG, the LSP commits to cover loan defaults up to a pre-agreed percentage of the loan portfolio it has sourced for the lender. For example, if the cap is 5%, the LSP will reimburse the lender for defaults up to 5% of the total value of the specified loan pool.
• Legal Framework: The Reserve Bank of India (RBI) issued formal guidelines on June 8, 2023, allowing and regulating such arrangements. These guidelines apply to all commercial banks, NBFCs (including housing finance companies), and cooperative banks.
• Cap on Guarantee: The RBI mandates that the FLDG (also called Default Loss Guarantee, DLG) cover cannot exceed 5% of the outstanding loan portfolio at any time.
• Invocation Timeline: If a borrower defaults, the guarantee must be invoked within 120 days of the loan becoming overdue, unless the default is resolved before that period.
• Contractual Clarity: The arrangement must be backed by a legally enforceable contract between the regulated entity and the LSP or DLG provider.
• Portfolio Eligibility: The guarantee applies to a fixed, identifiable portfolio of loans, not a dynamic or rolling pool.

Stakeholders

• Regulated Entities (REs): Banks, NBFCs, and cooperative banks benefit from reduced credit risk and are encouraged to lend to riskier segments.
• Fintech/LSPs: These entities demonstrate confidence in their credit assessment models by taking on first-loss risk, which can help them build trust with lenders and expand their business.
• Borrowers: Especially startups, small businesses, and individuals with limited credit history, gain better access to credit as lenders are more willing to extend loans backed by FLDG.

Impacts

• Promotes Responsible Lending: By requiring LSPs to share in the risk, the scheme ensures that fintech have “skin in the game,” incentivizing prudent borrower selection and robust credit assessment.
• Enhances Financial Inclusion: Lenders are more likely to serve new-to-credit and underserved segments, supporting broader financial inclusion goals.
• Boosts Digital Lending: The scheme supports the growth and credibility of digital lending platforms, making the ecosystem more transparent and accountable.
• Limits Risk Concentration: The 5% cap prevents excessive risk transfer and ensures that lenders retain primary responsibility for credit risk.
• Regulatory Clarity: The RBI’s guidelines clarify that compliant FLDG arrangements are not considered “synthetic securitisation” or “loan participation,” reducing legal and regulatory ambiguity.

In summary, the FLDG scheme is a critical innovation in India’s digital lending landscape, balancing risk-sharing between fintech and traditional lenders, promoting responsible lending, and expanding access to credit while maintaining regulatory oversight and consumer protection.

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Research Analyst: Sambit Roy

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