# FLDG / DLG Explained: The 5% Default Guarantee Cap

For years, one obscure three-letter acronym quietly powered much of India's fintech lending boom: FLDG — First Loss Default Guarantee. Then the Reserve Bank of India stepped in, renamed and redefined the structure as DLG (Default Loss Guarantee), and capped it at 5% of the loan portfolio. Understanding this rule is essential to understanding how risk is actually shared in Indian digital lending today.

What Is an FLDG/DLG Arrangement?

In a typical fintech-lender partnership, the fintech originates borrowers and the bank or NBFC lends. The lender worries about defaults; the fintech wants to prove its underwriting works. Enter the default guarantee:

  • The fintech (or another partner) agrees to compensate the lender for losses on a defined portfolio
  • "First loss" means the guarantor absorbs losses up to a fixed amount or percentage before the lender bears anything
  • In exchange, the lender may accept lower pricing, faster approvals, or lighter documentation

The structure let fintechs effectively transfer balance-sheet-like risk without holding a banking licence — which is precisely why it became controversial.

Why the RBI Capped It at 5%

The shadow balance-sheet problem

By 2023, some FLDG arrangements covered 20–30% or more of portfolio losses. Economically, the fintech was bearing most of the credit risk while the regulated entity merely warehoused loans. That undermined the core principle that only licensed, capital-adequate institutions should take credit risk.

The regulatory response

Through its Digital Lending Guidelines (August 2023) and subsequent Directions, the RBI formalised these deals as Default Loss Guarantee (DLG) with strict conditions:

  1. Cap: DLG cannot exceed 5% of the underlying loan portfolio
  2. Collateral: the guarantee must be backed by cash deposits, fixed deposits, or bank guarantees held by the regulated entity — not just promises
  3. Arm's length: arrangements must be at arm's length and properly documented
  4. Scope: DLG can be provided by the originating LSP, another RE, or a guarantor insurer; it must be invoked within the specified overdue period (typically not exceeding 120 days)

    5. What the 5% Cap Changes in Practice

    For lenders

    Banks and NBFCs now carry genuine skin in the game. A 5% buffer still cushions early-stage portfolios, but sustained default rates above that level hit the lender directly — so lenders scrutinise origination quality far more closely.

    For fintechs

    The era of "we'll guarantee everything" partnerships is over. Fintechs must demonstrate real underwriting strength rather than buying lender confidence with guarantees. Many have shifted to:

    • Fee-based LSP models with no risk transfer
    • Co-lending structures where they retain a minimum 10% share
    • Tighter borrower selection using verified data

    For borrowers

    Indirectly, borrowers benefit from more disciplined credit decisions and fewer predatory apps whose business model depended on high defaults plus steep guarantees.

    DLG vs Other Risk-Sharing Structures

    | Structure | Risk borne by fintech | Regulatory status |

    |---|---|---|

    | Pure LSP (fee-based) | None | Fully permitted |

    | DLG/FLDG | Up to 5% of portfolio | Permitted within cap |

    | Co-lending | Minimum 10% of its share | Permitted under co-lending framework |

    | Direct NBFC lending | Full exposure | Requires NBFC licence |

    Each rung involves deeper capital commitment and closer regulatory engagement.

    Where Risk-Sharing Still Makes Sense

    Well-designed credit products don't need outsized guarantees because the underlying transactions are self-verifying. B2B invoice-linked financing is a good example: platforms like KredFlow finance real commercial purchases — such as letting businesses pay annual SaaS contracts monthly while vendors get paid upfront — where GSTIN verification and an actual invoice anchor the credit decision. When repayment capacity is tied to a genuine transaction rather than a credit-score guess, lenders need less protection, and everyone pays less for risk.

    Key Takeaways

    • FLDG has been rebranded and regulated as Default Loss Guarantee (DLG) under RBI rules
    • The hard cap is 5% of the underlying portfolio, fully collateralised
    • Deals outside the cap are non-compliant; REs bear supervisory consequences
    • Fintechs are migrating toward fee-based LSP models and co-lending with genuine retention

    The 5% cap didn't kill risk-sharing in Indian fintech — it forced it into the open. Partnerships built on transparent, collateralised, modest guarantees are thriving; those built on hidden risk transfer are gone.