The DLG guidelines now provide a framework for issuing, monitoring and disclosing DLGs issued by LSPs. Interestingly, implicit guarantees or contractual arrangements providing credit enhancement or off-balance sheet support to REs that are linked to the performance of the RE’s loan portfolio will be treated as DLGs.

The DLG guidelines prescribe key elements that must be included in an express and legally enforceable contract between the RE and the DLG provider. These include:

• Extent of DLG cover (aggregate DLG cover amount for any outstanding portfolio which is specified upfront, cannot exceed five per cent of the total loan portfolio amount identified upfront);
• DLG cover that is to be maintained with the RE can only be in the form of cash deposited directly with the RE, fixed deposits held with a scheduled commercial bank and with a lien created in favour of the RE, or a bank guarantee issued in favour of the RE;
• The time limit for REs to invoke DLGs is 120 days from the date of a continuing default.
• REs must establish systems ensuring the LSPs with which they have a DLG arrangement publicly disclose on their website the number of portfolios and the amount in each portfolio on which DLGs have been extended. While this will ensure greater transparency, it will also pose practical challenges for LSPs as they will have to disclose their commercial DLG arrangements with all partners.

Before concluding any DLG arrangement, REs must establish a board approved policy. This policy must include essentials such as the eligibility criteria for DLG providers, the scope and nature of DLG coverage, procedures for monitoring and evaluating DLG arrangements and the details of any fees payable to DLG providers.

Whenever REs enter into a new DLG arrangement or renews an existing one, they must collect sufficient information to ensure that entities offering DLG are capable of fulfilling their obligations. This should include, at a minimum, a declaration from the DLG provider, verified by its statutory auditor, of total outstanding DLG amounts, the number of REs involved, the number of portfolios covered by DLG and historical default rates on similar portfolios.

The DLG guidelines mark a significant shift in the RBI’s stance towards DLGs. Under the previous guidelines, several digital lending players began restructuring their businesses. These regulations will be a lifeline for LSPs and for borrowers not traditionally serviced by REs because of a lack of collateral or sureties. The cap of five per cent on DLGs on an upfront identified portfolio will need some reworking as several LSPs usually provide and calculate this cap on a running basis on the outstanding portfolio at any given point in time.

The RBI’s decision to allow limited forms of DLGs and to establish comprehensive guidelines demonstrates a more nuanced approach to balancing risk and innovation in the digital lending sector. The guidelines should enhance transparency, enforceability, and stability, to the ultimate benefit of lenders and borrowers in the digital lending ecosystem.

This article was originally published in India Business Law Journal on 28 July 2023 Co-written by: Shubhangi Garg, Partner; Arjun Khandelwal, Associate. Click here for original article

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