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The guidelines by the Reserve Bank of India (RBI) on first loss default guarantee (FLDG) in digital lending, tightening the extent and form of FLDG cover, including limiting it to 5 per cent of loan portfolio, may dampen business volume in segments where these are currently higher than the permissible limit, said a CRISIL Ratings report on Monday.
“The RBI has tightened norms on the extent and form of FLDG cover, and recognition of non-performing assets (NPAs) in partnership models. These include limiting FLDG to 5 per cent of the loan portfolio and not allowing corporate guarantees as a form of FLDG. This could dampen business volume in segments where FLDGs are currently higher than the permissible limit,” it said.
The guidelines on FLDG in digital lending, announced by the Reserve Bank of India (RBI) on June 8 help resolve ambiguity around its use by banks and non-banking financial companies (NBFCs) as part of their co-lending arrangements. The report said that it also provides much-needed regulatory sanctity, even though there could be a near-term impact on business volume.
“We estimate that a substantial proportion of partnership/co-lending arrangements where FLDG is present — especially those with unsecured personal loan and business loan lenders — currently carry an FLDG cover of above 5 per cent. These segments would be affected by the new guidelines. On the other hand, secured asset classes such as home loans and loans against property, where FLDG is typically within 5 per cent, may not see much impact,” said Ajit Velonie, Senior Director, CRISIL Ratings.
Furthermore, permitting lending service providers (LSPs) to offer FLDG will enable lenders to continue working with non-NBFCs and non-regulated entities provided they are incorporated as a company. Additionally, the guidelines explicitly require recognition of loan assets as NPAs, in line with norms otherwise applicable to such loans, with the attendant provisioning, and irrespective of the FLDG cover available/invoked. This change will have an impact on the co-lending portfolio of banks that are acquiring lenders because reported asset quality metrics and gross credit costs would increase, it added. Some acquiring lenders, that are NBFCs, were already following such NPA recognition under Ind-AS accounting, and hence the impact on NPA recognition for these NBFCs should be lower.
But with the FDLG amount invoked and received no longer permitted to be used to reduce provisions, they, too, will see some increase in reported credit costs. However, there won’t be an overall impact on reported profits as the FLDG amount received will now be reckoned as a part of income.
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Consequently, changes such as the cap on FLDG cover and NPA recognition could dissuade some acquiring lenders from entering into partnerships in the higher-yielding segments, thereby leading to a preference for relatively less risky customer and asset segments, it said. That, in turn, would limit the growth of assets under management through the partnership mode for sourcing-NBFCs operating in higher-yielding segments.
Another important provision in the new guidelines is that non-cash forms of FLDG — other than bank guarantees —have been disallowed. Given that a reasonable proportion of FLDG is understood to be in the form of corporate guarantees, this could necessitate additional fund-raising by the sourcing-NBFCs involved, the report said.
“With the guidelines coming into effect immediately, we expect the co-lending market to see a drop in volumes in segments with relatively higher FLDG as the industry adjusts to the new normal. The market may see sourcing lenders adapting their business models to align with the revised regulations. For instance, in some asset classes, a higher hurdle rate could be offered to offset the impact of the cap on the FLDG cover. However, the situation we believe could take some time to stabilise,” said Ajit Velonie, Senior Director, CRISIL Ratings.
