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What is the purpose of the Default Loss Guarantee (DLG) guidelines in digital lending

What is the purpose of the Default Loss Guarantee (DLG) guidelines in digital lending

What is the purpose of the Default Loss Guarantee (DLG) guidelines in digital lending

The purpose of the Default Loss Guarantee (DLG) guidelines in digital lending is to provide a framework for the arrangement of DLG between Regulated Entities (REs) and Lending Service Providers (LSPs). These guidelines aim to ensure that DLG arrangements are conducted in a transparent and regulated manner, with the goal of protecting the interests of all parties involved. By establishing guidelines, the Reserve Bank of India (RBI) seeks to promote responsible lending practices and mitigate the risks associated with default losses in digital lending operations.

The guidelines on Default Loss Guarantee (DLG) in Digital Lending provide a comprehensive framework for the arrangement of DLG between Regulated Entities (REs) and Lending Service Providers (LSPs). These guidelines are applicable to various entities, including Commercial Banks (including Small Finance Banks), Primary (Urban) Co-operative Banks, State Co-operative Banks, Central Co-operative Banks, and Non-Banking Financial Companies (including Housing Finance Companies).

The DLG is defined as a contractual arrangement between the RE and an entity that meets the specified criteria. Under this arrangement, the entity guarantees to compensate the RE for losses due to default, up to a certain percentage of the loan portfolio specified upfront. Any other implicit guarantee of a similar nature linked to the performance of the loan portfolio and specified upfront is also covered under the definition of DLG. The guidelines emphasize the importance of robust credit underwriting standards and credit appraisal requirements, which should be in place regardless of the DLG cover.

They also require the RE to obtain adequate information from the DLG provider, including a declaration certified by the statutory auditor, which includes details on the aggregate DLG amount outstanding, the number of REs, the number of portfolios covered by DLG, and past default rates on similar portfolios. Additionally, the guidelines highlight that customer protection measures and grievance redressal issues related to DLG arrangements should be guided by the instructions contained in the “Guidelines on Digital Lending” dated September 02, 2022, along with other applicable norms.

How does the RBI define ‘synthetic securitization’ and why is it important for DLG arrangements to not fall under this category

The Reserve Bank of India (RBI) defines ‘synthetic securitization’ as a structured finance transaction that transfers credit risk from one party to another without transferring the underlying assets. In synthetic securitisation, the originator retains the underlying assets on its balance sheet and transfers the credit risk to investors through the issuance of credit-linked notes or other similar instruments.

It is important for DLG arrangements to not fall under the category of synthetic securitization because synthetic securitization transactions are subject to specific regulatory requirements and may attract higher capital charges. By not being classified as synthetic securitization, DLG arrangements can be conducted in a more flexible and efficient manner, without the additional regulatory burden.

DLG in Digital Lending, the RBI has clarified that DLG arrangements conforming to the guidelines laid down in the Annex to the circular shall not be treated as synthetic securitisation and shall not attract the provisions of ‘loan participation’. This provides clarity and support for DLG arrangements, which can help promote responsible lending practices and mitigate the risks associated with default losses in digital lending operations.

1. Eligibility Criteria: REs may enter into DLG arrangements only with a Lending Service Provider (LSP) or other RE with which it has entered into an outsourcing (LSP) arrangement. The LSP providing DLG must be incorporated as a company under the Companies Act, 2013.

2. Structure of DLG Arrangements: DLG arrangements must be backed by an explicit legally enforceable contract between the RE and the DLG provider. Such contract, among other things, must contain the following details: –

The percentage of the loan portfolio covered by DLG – The maximum amount of loss that can be compensated under the DLG arrangement – The term of the DLG arrangement – The conditions for triggering the DLG cover – The process for making claims under the DLG cover – The process for dispute resolution

3. Operational Aspects: The guidelines also provide detailed instructions on the operational aspects of DLG arrangements, including: – The process for obtaining adequate information from the DLG provider, including a declaration certified by the statutory auditor – The requirement for robust credit underwriting standards and credit appraisal requirements – The requirement for customer protection measures and grievance redressal issues to be guided by the instructions contained in the “Guidelines on Digital Lending” dated September 02, 2022, along with other applicable norms –

The requirement for REs to maintain appropriate records and reporting systems to monitor the DLG arrangements Overall, the guidelines aim to ensure that DLG arrangements are conducted in a transparent and regulated manner, with the goal of protecting the interests of all parties involved. By establishing guidelines, the RBI seeks to promote responsible lending practices and mitigate the risks associated with default losses in digital lending operations.

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