In the dynamic landscape of the financial industry, the role of First Loss Default Guarantee (FLDG) has emerged as a critical tool for lenders and regulated entities (REs) in securing their loan portfolios. Let’s delve into the significant aspects of FLDG and its impact on risk management, particularly after the recent Default Loss Guarantee (DLG) guidelines introduced by the Reserve Bank of India (RBI).
Understanding FLDG: A Game Changer for Risk Management
FLDGs are cooperative risk-sharing arrangements between a Regulated Entity (RE) and a Lending Service Provider (LSP). Under these agreements, the LSP guarantees defaults on loans that the RE extends to borrowers introduced by the LSP. FLDGs take on various forms, including funded risk participation through methods like cash deposits, and non-funded risk participation in the form of corporate guarantees or bank guarantees. It’s also possible to combine funded and non-funded risk participation. The percentage of risk participation, which is determined collaboratively by the RE and LSP, is typically limited and depends on factors such as the lending segment, the LSP’s credibility, and market reputation, among others.
Maximum FLDG Limit: As per the new guidelines, FLDG can now constitute up to 5% of the total portfolio in the arrangement between the RE and Lending Service Provider (LSP) or between two Regulated Entities.
Applicability of FLDG: FLDG applies to arrangements between Regulated Entities and LSPs or between two Regulated Entities. This extends the scope of risk management in the financial sector.
Also Read: Will I have to pay tax on the residual amount after selling an old flat and buying a new one?
DLG Invocation: One key feature is that DLGs can be invoked within 120 days, providing a safety net for lenders in case of borrower defaults.
Flexible Guarantee Forms: DLGs can take multiple forms, including cash deposits, bank guarantees, or fixed deposits maintained with scheduled commercial banks. This flexibility allows lenders to tailor their risk management strategies to their specific needs.
Transparency: LSPs are required to publish details of the total number of portfolios and their respective amounts on which FLDG has been offered on their websites. This transparency enhances accountability and trust in the system.
NPA Recognition: It’s important to note that REs remain responsible for recognizing individual loans in the portfolio as Non-Performing Assets (NPAs) and making necessary provisioning, regardless of the FLDG cover at the portfolio level.
The Power of FLDG: Enhancing Risk Management
The FLDG framework acts as a safety net for lenders and regulated entities, offering protection against potential defaults from borrowers. This serves as a crucial risk management tool, enabling banks, non-banking financial companies (NBFCs), and other financial institutions to handle their credit risk more effectively.
Improved Risk Management: FLDG empowers financial institutions to proactively manage and mitigate credit risk. By providing a first layer of protection against potential losses, it helps in safeguarding the overall portfolio.
Measured Risk Exposure: The clear definition of FLDG limits, as per the RBI guidelines, ensures that lenders have a structured approach to risk management. It encourages prudent lending practices and risk assessment.
Enhanced Stability: FLDG contributes to the stability and sustainability of the financial sector. It helps institutions maintain a strong financial position and weather economic downturns more effectively.
Also Read: How to plan your year-end vacation wisely and save money
Regulatory Compliance: Adherence to the new DLG guidelines is essential for financial institutions to ensure compliance with RBI regulations, fostering trust and integrity in the industry.
In conclusion, FLDG has evolved into a vital instrument in the financial sector’s risk management toolbox. With the recent DLG guidelines, it has become more structured, transparent, and accountable. FLDG empowers lenders and regulated entities to secure their loan portfolios, improve risk management, and navigate the complexities of the evolving financial landscape.
This article has been written by Chintan Panchmatiya, Founder, Switch My Loan. Views are personal
Leave a Reply