The Reserve Bank of India (RBI) has approved the First Loss Default Guarantee (FLDG) program, a lending model between fintech firms and their partner banks and non-banking finance companies where the initial hit on a default is taken by the fintech firm that originated the loan.

Banks and non-banking financial companies are required to take a cooling off period from borrowers subject to compromise settlements, the RBI said, before they can lend them further.

The central bank set the non-farm credit cooling period at minimum 12 months, and said the period for farm credit will be approved by the board of the lender.

Lenders can undertake compromise settlements for loan accounts classified as fraud or those of wilful defaulters, the RBI said. Compromise settlement refers to an arrangement with the borrower to fully settle the lender’s claim in cash.

Separately, the RBI on Thursday also released a regulatory framework for default loss guarantee (DLG) for digital lenders after examining the first loss default guarantee (FLDG) mechanism.

The RBI has allowed regulated entities to enter into default loss guarantee arrangements, but within limits. A default cover could be provided for up to 5% of the loan portfolio of the entity.

The lenders shall invoke DLG, and initiate loan restructuring, within a maximum overdue period of 120 days, the central bank added.

The recognition of individual loan assets in the portfolio as non-performing asset and consequent provisioning shall be the responsibility of the regulated entities, the central bank added.

In guidelines issued in 2022, the RBI had indicated it was not in favour of such arrangements since they could encourage lenders to take on undue risk.