In recent years, the digital lending space in India has been growing rapidly, thanks to the rise of fintechs. These fintechs use technology to provide quick and easy access to credit for individuals and small businesses, filling the gap left by traditional banks and non-banking financial companies (NBFCs). However, the Reserve Bank of India (RBI) has recently banned the Fair Lending Disclosure Guidelines (FLDG) arrangement, which was a crucial mechanism used by fintechs to guarantee loans.
What was the FLDG arrangement?
The FLDG arrangement allowed fintechs to provide a guarantee to compensate for up to a certain percentage of default in a loan portfolio. Under this arrangement, the fintech company gives a guarantee to the bank or the NBFC that it will compensate a certain percentage of default in a loan portfolio to minimize losses caused by defaults. This mechanism allowed fintechs to lend more freely, as it reduced the risk of default for the banks and NBFCs. In return, the fintechs charged a fee for the guarantee provided.
Why was the FLDG arrangement banned?
The RBI has banned the FLDG arrangement under its digital lending guidelines due to concerns regarding fintechs taking on default risks without regulation. The central bank stated that fintechs cannot engage in any lending activity without being registered as an NBFC or a bank. The RBI also stated that fintechs should not be permitted to undertake any activity where they take on the risk of the underlying credit extended.
What are the alternatives?
To replace the FLDG arrangement, fintechs are now exploring co-lending agreements, collection efficiency models, and revenue-sharing models as alternatives. Some fintechs are also collaborating with regulated entities to reduce regulatory risks. Co-lending agreements involve fintechs partnering with banks or NBFCs to offer loans jointly. This allows fintechs to lend more freely, as they can use the banks’ or NBFCs’ existing infrastructure to underwrite and disburse loans.
Collection efficiency models involve using technology to optimize the collection process for loans. This can involve using automated calling and messaging services to remind borrowers about their loan repayments, as well as using analytics to identify borrowers who are at high risk of default. Revenue-sharing models involve fintechs sharing a percentage of the interest earned on loans with banks or NBFCs in exchange for access to their lending infrastructure.
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