Reserve Bank of India Clarifies Guidelines for Default Loss Guarantee in Digital Lending

The Reserve Bank of India (RBI) released a comprehensive set of Frequently Asked Questions (FAQs) to elucidate its guidelines on Default Loss Guarantee (DLG) in the burgeoning field of digital lending.

This release aims to provide detailed clarifications on the operational aspects of DLG, a financial safety mechanism where an entity commits to compensating a bank for losses due to defaulted loans up to a predetermined percentage of the bank’s loan portfolio.

The RBI initially set forth the DLG guidelines in June 2023, with a cap that the total DLG cover on any outstanding loan portfolio should not exceed five percent of the portfolio’s value.

This regulation was designed to limit the exposure of banks and safeguard the financial system by mitigating the risks associated with defaults in digital lending.

The newly issued FAQs clarify that only loan portfolios consisting of identifiable and measurable loan assets are eligible for DLG coverage.

Importantly, these portfolios must be fixed in composition and are not intended to be dynamic, ensuring stability and predictability in the coverage provided.

Furthermore, the FAQs specify that the DLG cap applies to the total amount disbursed at any one time and that once a DLG claim is made by a recipient entity, it is final and cannot be reinstated, even if some of the loans are later recovered.

In terms of policy implementation, the RBI mandates that banks offering DLG must have a Board-approved policy to govern these guarantees effectively.

This requirement also extends to banks that serve as DLG providers, emphasizing the need for stringent oversight and prudent management of these financial arrangements.

These clarifications come at a crucial time as digital lending continues to expand rapidly within India’s financial landscape, driven by technological advancements and growing consumer demand for digital financial services.

The RBI said it seeks to enhance risk management practices and maintain financial stability in the sector by reinforcing the framework for DLG.  This initiative is part of a broader effort by the RBI to regulate and foster a healthy digital lending environment.

It also aims to protect the interests of both banks and borrowers, ensuring that digital lending grows in a controlled and responsible manner by providing clear guidelines and robust regulatory support.

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