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RBI’s New Digital Lending Rules that allow Loss Guarantees by Startups


Fintech startups get a kinda-sorta reprieve from tough Uncle RBI, who first said this: NO GIVING GUARANTEES ON LOANS. Now it’s like, Ok, give some guarantees. But obviously, like all Harry Potter novels, danger lurks ahead.

Instead of boring you with details, let’s try and talk it out, like a fintech startup to a financial entity.

Akhir tum kehna kya chahte ho, fintech startup? What do you want to say? (Asks the bank or NBFC) 

So, we know lots of things about people because we have apps that know where they are, what they buy and how much they pay for things. By scanning through their SMSes.

Really? What do they buy?

Leave all that. We therefore think we can help these people get loans. Because such people, despite what you think, need money. So we’ll get you hajaar loans. “Source” them, I mean.

Oh. Look boss, we’re a bank or an NBFC. One of the above. We can’t just lend because you tell us you’ve read someone’s SMS. Such voyeuristic lending is ok for VCs but how do you know they won’t default?

Well, we have models. But obviously you, not being fintech, have no clue how the new generation works. So you are afraid that people will default? I’ll tell you this: if people default, we’ll take the hit because we have raised money from, uhm, VCs and all. First Loss Default Guarantee (FLDG), it’s called. You lend, because you have the license. We’ll even give you the money to lend. If there’s a hit, we’ll absorb it.

Why don’t you lend yourself, if you’re this confident?

Arey baba, if I could lend I would. But I can’t because it needs an RBI license, which they won’t give us because we have losses and non-Indian investors and all such things. So I have to go through people like you.

That makes sense, but wait, RBI banned default guarantees like this earlier. They want NBFCs like us to actually lend, versus depending on you people, who aren’t regulated and can vanish and do strange things like disqualify your lenders and all that. And since RBI doesn’t regulate you, they can’t accept your “guarantee” in any form. 

But no, they’ve changed it again! See the recent regulation bro. (For older people: note that everyone is “bro”)

Hang on. Let’s read the regulation together. What does it say really? Why don’t we ask RBI?

RBI: You can get some default guarantee from a startup. (Startup smiles).

  • But only to the extent of 5%. Meaning, if you have sourced loans worth Rs. 100 cr. from startup, you can guarantee only Rs. 5 cr. of those loans.
  • If defaults are more than 5%, then the guarantee giver should only pay upto 5%, and the Bank or NBFC takes the hit beyond that.
  • That 5% needs to be paid upfront to the bank or NBFC by the startup. In an FD pledged to the lender, or in cash , or in a bank guarantee. The money can be taken piecemeal from this deposit.
  • And listen, we have a big problem with you thinking of this as some sort of loss-sharing like in synthetic securitization. Meaning, the financial company (bank or NBFC) doesn’t get to say it’s only lent Rs. 95 cr. just because there’s a 100 cr. pool with 5% FLDG.
  • More importantly, on NPAs: If you lend to Deepak, and he doesn’t pay back, but the startup pays you Deepak’s outstanding, Deepak is STILL an NPA. He will remain an NPA on your books until you either write-off the money or try to recover it in some way. If you do recover something, you can share that recovery with the startup. But if you pretend that Deepak is not an NPA just because of the default guarantee, I swear I’ll fry your ass. Bro.
  • Effectively, your NPAs will not go down just because you have a default guarantee from someone.

This is good, but I don’t like the NPA bit (says the NBFC or bank). Even if you pay me, I still have to show this money as an NPA – which increases my NPAs and makes my borrowing costs higher!

Startup: Look there’s a clause for us also. On our website, we must show how much we’ve guaranteed in total on all types of loans. Plus, we have to transfer the money upfront to you – we can’t use the money even when there is no default. Plus, every time we want to create a default guarantee with a new bank, we have to give audited details of how much we’ve guaranteed at other places and what the default rates were. This can be a little cumbersome, but it’s still a leg in: will you do this anyhow?

Bank or NBFC: Look, there’s only two issues: Your guarantee is only till 5% (so higher losses are still on us) and your bad loans remain NPAs for us despite your guarantee and payment. But otherwise, it does give us more comfort to lend to your customers, if you can ensure that the losses remain limited over time. 

Note: “Startups” is just for this conversation. Any company can provide a guarantee.

Our view

This is good for many companies that have the ability to source short term business credit where repayment histories are known to certain companies, like payment providers. They can now officially make good any defaults from their customers, with some comfort derived from historical business flows through them. What it does do though is create a guarantee that’s actually deposited into the actual lender, so that the lender doesn’t have to run around behind the startup if there are defaults.

The NPA bit is a mess, especially for listed NBFCs and banks, where a spike in NPAs can cause serious issues with the stock prices. We should expect more “technical write-offs” in such NBFCs or banks who partner with others using Loss Default Guarantees.

This can spur digital lending substantially, where losses are relatively low. The banks and NBFCs need to watch out for evergreening – the same borrowers taking more and more loans to stay out of the “NPA” list. The startups need to build even better lending models. Because we’ve heard that certain small NBFCs who directly lend digitally have a default rate of 20% or more! The smarter startups don’t guarantee any loans; they just charge the borrower an entry fee for the loan (which is up to 3%!) and leave the entire risk on the NBFC/Bank. They might be able to grow even faster if they guarantee part of the loans too.

The biggest beneficiary will be small banks, small and large NBFCs, and of course, the fintech ecosystem. The idea is to find places where loss ratios are small; but the problem is that most VC funded startups need to grow like crazy. And growing like crazy usually tends to be growth first, defaults later, so the pain may still be ahead of us. Eventually, good lending will win, and First Loss Default Guarantees will only be useful if they aren’t exercised.


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