Reserve Bank of India's Directive on Default Loss Guarantees (DLGs)
The Reserve Bank of India (RBI) has instructed finance companies to exclude DLGs provided by fintech firms when making provisions for stressed loans. This move affects independent digital lending service providers significantly.
Impact on Non-Banking Finance Companies (NBFCs)
- NBFCs must now make full regular provisions on loans sourced from fintech platforms, potentially reducing their appeal for new business.
- As per the RBI's communication, credit enhancements under DLG arrangements should be excluded from expected credit loss computations by March 31, 2025, with implementation by September 30.
- Some NBFCs began making additional provisions starting the fourth quarter of FY25.
Role of Digital Lending Partners
- Digital partners such as MobiKwik, Paytm, and Moneyview operate as Lending Service Providers (LSPs), originating and servicing loans for NBFCs.
- These partners provide DLGs, typically capped at 5%, as compensation for potential loan defaults. DLGs are often held as fixed deposits, lien-marked in favor of NBFCs.
Financial Implications
- The directive encourages NBFCs to enhance their underwriting skills, reducing reliance on fintech partners.
- For fintech, there will be a decline in origination volumes, fee income, and overall earnings.
- Loans from fintech firms usually account for less than 10% of an NBFC's portfolio, with most being short-term, unsecured personal loans at interest rates of 16% to 22%.
Rationale Behind RBI's Measures
The move is partly due to a large fintech company's collapse last fiscal year, which had to provide Rs 172 crore as DLGs to NBFCs. Only after a capital infusion by a Singapore company was the firm able to manage the DLGs.
Illustrative Example
- Previously, for a Rs 100 crore loan pool with an 8% expected loss, NBFCs set aside Rs 3 crore when Rs 5 crore was deposited upfront as DLG.
- Now, NBFCs are required to provision the entire Rs 8 crore upfront, with the DLG amount eligible for writeback upon loan maturity.
Economic Impact
- The directive has impacted the earnings of at least three NBFCs.
- For instance, SMFG India Credit, backed by Sumitomo Mitsui Financial Group, saw a net profit drop to Rs 344 crore in FY25, a 78% decrease from FY24, due to requiring an additional Rs 115 crore provision for DLGs.
