RBI Directive on Default Loss Guarantee (DLG)

What is Default Loss Guarantee (DLG)?

• A contractual arrangement where a fintech entity guarantees to compensate lenders (banks or NBFCs) for losses arising from loan defaults.
• Typically covers losses up to 5% of the loan portfolio.
• Acts as a risk mitigation tool for lenders partnering with fintechs in loan origination.

Key Highlights of RBI’s Directive

• NPA Recognition and Provisioning:
  • Lenders must exclude DLG cover while recognizing Non-Performing Assets (NPAs) and making provisions.
  • DLG invocation does not affect borrower liability on the underlying loan.
  • The DLG amount invoked cannot be set off against the underlying individual loans.
  • Lenders are required to recognize NPAs and make provisions independently, irrespective of DLG coverage.
• Recovery and Invocation:
  • Recovery proceeds from loans with invoked DLG may be shared with the DLG provider as per contract terms.
  • Once invoked, the DLG cannot be reinstated, even if loan recoveries occur later.
• Rationale and Impact:
  • Intended to address overreliance of fintechs on DLG for credit risk management.
  • Places full responsibility for NPA recognition and provisioning on lenders, enhancing prudence.
  • Expected to lead to reduced co-origination partnerships between banks and fintechs due to increased lender risk exposure.
  • Seen as a credit tightening measure by RBI to ensure caution in lender-fintech partnerships.

Additional Recent Update (May 2025)

• RBI is seeking approval to allow domestic banks and their foreign branches to lend Indian Rupees to overseas borrowers for the first time, marking a significant move in international banking operations.

Implications

• Strengthens risk management discipline among lenders and fintechs.
• Could reshape fintech lending business models that depend on DLG.
• Enhances transparency and accountability in loan loss provisioning.
• May impact fintech-bank collaborations, influencing credit availability in certain segments.