Default Loss Guarantee for NBFCs in India: How the Rules Changed in 2025-2026

Default Loss Guarantee (DLG), also called First Loss Default Guarantee (FLDG), is a credit enhancement mechanism where a fintech or Digital Lending Platform provides a guarantee to the NBFC or bank partner, covering the first-loss tranche of defaults on a jointly originated portfolio.

Two significant regulatory changes in the past 18 months. The RBI issued revised DLG directions in August 2025. Subsequently, in February 2026, the RBI introduced a further amendment to the ECL provisioning framework, specifying how lenders must treat DLG arrangements under the Expected Credit Loss framework. This guide covers the current operative framework.

What DLG Is and How It Works in NBFC Fintech Partnerships

In a DLG arrangement, a fintech company or Lending Service Provider (LSP) guarantees a specified percentage of losses on a loan portfolio that the NBFC has originated through its partnership with the fintech. In a DLG arrangement, a fintech company or Lending Service Provider (LSP) guarantees a specified percentage of losses on a loan portfolio that the NBFC has originated through its partnership with the fintech.

For example: an NBFC originates Rs 100 crore in personal loans through a fintech DSA channel. The fintech provides a 4% DLG guaranteeing the NBFC against the first Rs 4 crore in portfolio losses. The NBFC bears losses above Rs 4 crore.

The DLG mechanism reduces the NBFC’s perceived credit risk on fintech-sourced portfolios and incentivises the fintech to maintain origination quality because the fintech bears the first loss. Consequently, by providing DLG, fintechs can access the NBFC’s balance sheet at scale because they assume part of the credit risk arising from poor-quality loan origination.

The August 2025 DLG Directions: Key Changes

RBI August 2025 DLG Directions extended and clarified the DLG framework that was first introduced in June 2023. Key changes introduced in August 2025:

• Additionally, the RBI now explicitly permits DLG arrangements for co-lending transactions alongside standard NBFC-LSP digital lending partnerships. As a result, this extension significantly expands the scope of DLG. Furthermore, it allows DLG to provide credit enhancement for large-volume bank-NBFC co-lending programmes, thereby supporting broader adoption of co-lending models.
• DLG cap reconfirmed at 5%: the maximum DLG is 5% of the outstanding loan portfolio covered by the arrangement. Importantly, the RBI does not permit DLG structures above 5% because it treats them as credit risk transfers that circumvent prudential norms.
• Every time the DLG provider honours a guarantee claim, the NBFC must recalculate the ECL provisions for the portfolio. This prevents the DLG from masking actual credit deterioration in the provision calculations.
• Strict underwriting non-substitution: Importantly, the Directions explicitly state that DLG does not substitute for rigorous credit assessment. Accordingly, NBFCs must use DLG only as a supplement to underwriting. Otherwise, they violate both the letter and the spirit of the Directions.

DLG Under the ECL Framework: February 2026 Amendment

The RBI addressed a key question through the February 2026 IRACP Amendment Directions: how should lenders treat DLG arrangements in the ECL provisioning calculation?

The RBI permits NBFCs to factor DLG coverage into ECL calculations and reduce the Expected Credit Loss provision by the amount of available DLG coverage. However, NBFCs must satisfy two conditions before they can apply this treatment:

• Condition 1: IndAS compliance: the NBFC must ensure compliance with Indian Accounting Standards requirements for DLG recognition. IndAS 109 mandates that the DLG arrangement must be an integral component of the contractual loan terms, not a separate off-balance sheet guarantee.
• Condition 2: The NBFC should not recognise or account for the DLG as a separate financial guarantee instrument. It must be part of the underlying loan economics.

Consequently, this treatment aligns the prudential recognition of DLG with the Ind AS 109 framework that NBFCs already follow. As a result, it prevents a divergence between accounting and regulatory provisioning for DLG-covered portfolios.

DLG Cap: What the 5% Limit Means in Practice

The 5% DLG cap has specific practical implications for fintech-NBFC partnership structures.

On a Rs 500 crore portfolio, the maximum DLG is Rs 25 crore. For example, if the fintech company covers 5% of the portfolio and the portfolio records a 6% NPA, the company fully utilises the DLG. Thereafter, the NBFC absorbs the remaining 1% (Rs 5 crore) loss itself. Consequently, the 5% cap ensures that the NBFC retains meaningful credit risk and therefore cannot fully transfer the risk of poor loan origination to the fintech.

NBFCs that have structured DLG programmes above 5% through creative structures involving multiple guarantee layers are in regulatory non-compliance. The RBI has been explicit that regulatory arbitrage through DLG stacking is not permitted.

Compliance Requirements for NBFC DLG Programmes

• Documented arrangement: The parties must document every DLG in a written agreement that specifies the guaranteed portfolio, the DLG percentage, the claim trigger conditions, and the claim process.
• Separate escrow: Additionally, the fintech must hold DLG funds in a separate escrow account rather than merely commit to providing them. It must set aside the cash or liquid equivalent and keep those funds separate from its general operations.
• Regular review: the Board must review DLG arrangements quarterly, assessing portfolio performance against DLG coverage and flagging programmes where the portfolio NPA is approaching the DLG ceiling.
• No DLG as an underwriting substitute: credit files on DLG-covered loans must show the same quality of bureau analysis, income verification, and consent documentation as non-DLG loans. RBI examiners specifically check DLG-covered portfolios for underwriting shortcuts.

Key Takeaways

• The RBI permits NBFCs in India to use Default Loss Guarantees as a legitimate credit enhancement mechanism, subject to a 5% cap on the covered portfolio. It reduces the NBFC’s first-loss exposure on fintech-sourced portfolios without substituting for underwriting rigour.
• August 2025 DLG Directions extended DLG to co-lending transactions and required mandatory ECL recalculation on each DLG utilisation event.
• February 2026 IRACP Amendment permits NBFCs to factor DLG into ECL provision calculations subject to IndAS 109 integral contractual terms and non-separate recognition conditions.
• The fintech must hold DLG funds in a separate escrow account; the RBI prohibits DLG arrangements above 5%, and lenders must maintain the same underwriting quality for DLG-covered loans as they do for non-covered loans.

Frequently Asked Questions

Conclusion

Default Loss Guarantee for NBFCs in India occupies a useful and now well-defined regulatory space. Used correctly as a first-loss credit enhancement supplementary to rigorous underwriting it enables fintech-NBFC partnerships to scale digital lending with appropriate risk alignment.

The 2025-2026 regulatory developments have clarified the ECL treatment, extended the framework to co-lending, and tightened the governance requirements. The NBFC that uses DLG has designed a supplement to quality, not a substitute for it is in compliance and benefits from the arrangement.