FLDGs raise the bigger question of accountability in India’s digital credit evolution

The Indian digital lending ecosystem was poised to surpass $350 billion in potential volume as of last year. Fintech platforms—backed by private capital and tech-led innovation—were promising to transform traditional credit flows, offering banks and NBFCs access to new borrower segments through digital origination, alternate underwriting models, and customer lifecycle management.

The Reserve Bank of India’s policy announcement on the First Loss Default Guarantees (FLDGs) seemed like a pragmatic bridge, providing regulated lenders with a measure of protection while enabling fintechs to scale outreach and demonstrate some skin in the game.

However, two years and multiple regulatory interventions later, the re-articulated FLDG guidelines introduced in November 2024 suggest a more cautious policy stance. 

One school of thought views FLDGs as a risk-mitigating enabler of co-lending, while another flags concerns around moral hazard, incentive asymmetry, and risk of creating a parallel credit ecosystem with limited regulatory accountability.

The time is ripe for India to reconsider the debate around FLDGs. It needs to move beyond binaries, and the ecosystem needs to look at ways to operationalise them as a viable, credible risk-sharing tool or scout for other mechanisms that can enable accountability.

FLDGs: Of innovation, oversight, and reset

At its essence, the FLDG construct allows a non-regulated partner—typically a fintech or digital platform—to absorb the first loss on a defined pool of loans, offering comfort to regulated entities or lenders.

This form of contingent risk participation not only lowers entry barriers for high-risk segments but also fosters co-innovation between banks and tech players.

In practice, FLDGs catalysed credit penetration across underserved markets, particularly among gig economy participants, first-time borrowers, and thin-file MSMEs. They aligned commercial incentives, improved asset selection through data-driven models, and enabled greater participation from lenders who may otherwise have remained risk-averse.

In 2022, the RBI raised concerns over unregulated FLDG arrangements that effectively shifted credit risk without adequate disclosure or capital provisioning. The opaque nature of deals and risks, as well as to avoid the risk of contagion, caused the RBI to step in.

The November 2024 circular brought a calibrated framework, and many fintechs rejoiced that FLDGs were permitted, but subject to a 5% cap on the underlying loan portfolio. Additionally, there were strict requirements around contractual clarity, board-level approvals, and third-party auditability. And, fintechs saw this as a workable compromise. 

Structuring risk or obscuring it? 

We need to ask ourselves whether FLDGs are offering a measurable instrument to align originator-lender incentives, or are they obscuring the risk?

Incentive misalignment becomes pronounced, especially with fintechs chasing volumes, fully aware that a regulated entity would bear 95% of their loss exposure. However, the implicit comfort of a guarantee dilutes the need for robust underwriting discipline.

Many fintechs, in practice, are likely to transfer the cost of the guarantee to the borrower, which could result in higher effective interest rates, especially in unsecured or high-frequency products, such as Buy Now Pay Later (BNPL), trade finance terms, or even working capital credit crucial to MSMEs.

Without such transparent disclosures, such loans may erode borrower trust and widen the perception gap around affordability.

To a great extent, there is also the fear of regulatory arbitrage, as FLDG-backed models allow fintechs to simulate lender-like economics without adhering to corresponding capital norms, prudential guidelines, or provisioning requirements, creating a level playing field vis-à-vis regulated credit institutions.

A 5% cap may contain some risks, although larger policy questions may persist. Some may even wonder whether FLDGs incentivised a parallel credit architecture, blurring regulatory oversight. 

The opportunity of a platform economy

Despite headwinds, it would be short-sighted to dismiss FLDGs altogether. In the platform economy, credit often follows user behaviour and not traditional credit scoring. Embedded finance, agri-lending, and value-chain credit models require real-time data integration and contextual underwriting—capabilities that fintechs are uniquely positioned to offer.

Here, FLDGs function less as a bailout mechanism and more as a trust signal, affirming the originator’s confidence in their risk models. For incumbent lenders, this facilitates faster decision-making, greater comfort in onboarding new segments, and the opportunity to diversify portfolios with better-structured downside protection.

Moreover, FLDGs have the potential to advance India’s financial inclusion goals. With structured guarantees and shared loss frameworks, lenders can extend credit to first-time borrowers or informal workers—segments that conventional scorecards often fail to serve—while still maintaining acceptable risk-adjusted returns.

However, long-term sustainability rests on three pivots—robust governance, independent underwriting by lenders, and standardised disclosures towards transparent intermediation. 

FLDGs occupy a grey zone—part innovation, part workaround. But when used prudently, they should strengthen trust between traditional and digital lenders, improve risk pricing, and unlock capital for underpenetrated markets.

RBI’s intent regarding FLDGs is clear: risk cannot be outsourced without accountability. But without regulatory discipline, they can just as easily become a systemic crutch—obscuring risk, inflating borrower costs, and distancing credit decisions from prudential principles.

To a great degree, RBI’s Digital Lending Framework 2.0 has provided a scaffolding, but the next phase of credit evolution will be driven by shared accountability and calibrated innovation. 

Rohit Arora is the Co-founder and CEO of Biz2Credit and Biz2X