Guidelines on Default Loss Guarantee in Digital Lending

The digital lending sector has received a significant boost from the Reserve Bank of India (“RBI”) through its recently issued Guidelines on Default Loss Guarantee in Digital Lending (“DLG Guidelines”) on June 8, 2023. These guidelines outline the terms and conditions governing the ability of RBI-regulated lending entities (“RE”) to engage in default loss guarantee (“DLG”) agreements with each other or with lending service providers (“LSP”). The DLG Guidelines have been introduced following extensive discussions between RBI and the fintech industry. This follows RBI's earlier decision to categorize guarantee arrangements between LSPs and REs as “synthetic securitisation” , which had raised concerns that DLG arrangements might not be permissible in the digital lending environment. The terminology concerning loss-sharing models has posed a challenge for the Reserve Bank of India (RBI) for quite some time. Following the issuance of the Guidelines on Digital Lending on September 2, 2022 (“September Guidelines”), there was confusion in the regulatory landscape regarding the validity of these models. The September Guidelines did not explicitly prohibit loss-sharing arrangements but hinted at adhering to paragraph 6(c) of the Reserve Bank of India (Securitization of Standard Assets) Directions, 2021 (“Scrutinization Directions”), for financial products involving contractual loss-sharing methods, which could have any of the following interpretations:

a. Synthetic securitization pertains to an agreement closely linked to the credit risk connected with a group of loans, enabling fintech companies to offer guarantees for individual loans.

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