Loan portfolio protection: How First Loss Default Guarantee (FLDG) helps financial institutions

financialexpress.com:

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).

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.

Clarity on FLDG Percentage: Before the introduction of DLG guidelines, the percentage of FLDG was not clearly defined. Lenders enjoyed the flexibility of covering their portfolios up to 100%, which was often classified as synthetic securitization. However, the recent circular on DLG has set specific parameters for FLDG.

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