Banks, NBFCs, and fintech businesses are still waiting for clarification on a number of issues, including the First Loss Default Guarantee (FLDG) mechanism, two months after the RBI released rules on digital lending.
FLDG System
- A FLDG is a contract between a fintech firm and a regulated entity (RE), such as a bank or non-banking finance company, whereby the fintech partially reimburses the RE in the event of a default by the borrower.
- In this scenario, the fintech originates a loan and guarantees to reimburse the partners up to a predetermined percentage in the event that clients default on their payments.
- Through the fintech, the bank/NBFC partners lend, but from their own books.
- Although it depends on the fintechs’ underwriting abilities, FLDG aids in growing the clientele of conventional lenders.
- A validation of the fintech’s loan underwriting ability is also apparent in FLDG.
Problems with FLDGs
- Risks of FLDG agreements with unregulated businesses were outlined in a report by a working group on digital lending that the RBI had established.
- Another issue is that FLDG expenses are frequently passed forward to customers.