Report: RBI’s FLDG Norms Will Affect Volumes and Affect Some Segments

Although the Reserve Bank’s new rules on first loss default guarantee (FLDG) in digital lending provide much-needed clarity, Crisil Ratings warned on Monday that they might have a negative effect on certain market sectors.

According to the domestic rating agency, the rules unveiled on June 8 would assist clear up any confusion around the usage of FLDGs by banks and non-banking financial institutions as part of their co-lending agreements.

Even if there can be a short-term effect on company volume, it also offers much-needed regulatory clarity, the agency added.

According to the agency, the RBI has tightened regulations on the scope and nature of FLDG coverage and the identification of non-performing assets (NPAs) under partnership arrangements, such as capping FLDG at 5% of the loan portfolio and prohibiting corporate guarantees as a form of FLDG due to their potential to reduce business activity.

“We estimate that a FLDG cover of over 5% is now carried by a significant fraction of partnership/co-lending agreements where FLDG is present, particularly those with unsecured personal loan and business loan lenders. The new regulations would have an impact on these divisions, according to the agency’s senior director Ajit Velonie.

Velonie said that there may not be much of an effect on secured asset classes where FLDG is normally within 5%, such as house loans and loans backed by property.

Because the guidelines explicitly call for the recognition of loan assets as NPAs in accordance with standards that would otherwise apply to such loans, with the attendant provisioning and regardless of the FLDG cover available/invoked, Crisil said there may also be an increase in the banks’ NPAs in their co-lending portfolios.

The new regulations won’t have an effect on certain NBFCs that utilise the Ind-AS style of accounting since they already record such stress as NPAs in their books.

The FDLG amount invoked and received is no longer permitted to be used to reduce provisions, the agency stated, adding that even for such NBFCs, the credit costs may increase. However, there won’t be a general impact on reported profits as the FLDG amount received will now be reckoned as a part of income, the agency added.

The agency stated that some acquiring lenders may be discouraged from entering partnerships in the higher-yielding segments as a result of the changes, such as the cap on FLDG cover and NPA recognition, leading them to prefer relatively less risky customer and asset segments. This would limit the growth of assets under management through the partnership mode, the agency said.

The regulator said that a fair part of FLDG is in the form of company guarantees and that NBFCs may also need to raise money since non-cash forms of FLDG, aside from bank guarantees, are currently prohibited.

As the sector adapts to the new normal, “we expect the co-lending market to see a drop in volumes in segments with relatively higher FLDG,” managing director Subha Sri Narayanan said.