What is a Non-Banking Financial Company (NBFC)?
A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956, that engages in financial activities such as loans and advances, acquisition of shares, stocks, bonds, debentures, and other marketable securities. They also partake in leasing, hire-purchase, insurance, and chit business. Unlike traditional banks, NBFCs cannot accept demand deposits (funds withdrawable on demand, like those in a checking account). Their operations do not primarily involve agricultural, industrial activities, the purchase or sale of goods (other than securities), or the construction and sale of immovable property. Some NBFCs, known as Residuary Non-Banking Companies, focus on receiving deposits under various schemes or arrangements.
Differences Between Banks and Non-Banking Financial Companies (NBFCs)
While NBFCs lend and make investments similar to banks, there are several key differences between the two types of financial institutions:
Acceptance of Demand Deposits:
- Banks: Can accept demand deposits, which are with drawable on demand (e.g., savings accounts, current accounts).
- NBFCs: Cannot accept demand deposits. They primarily rely on term deposits and other funding sources.
Payment and Settlement System:
- Banks: Are integral to the payment and settlement system. They can issue cheques and provide other payment services.
- NBFCs: Do not form part of the payment and settlement system and cannot issue cheques drawn on themselves.
Deposit Insurance:
- Banks: Deposits in banks are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC) up to a certain limit, providing a safety net for depositors.
- NBFCs: Depositors of NBFCs do not have access to the deposit insurance facility provided by DICGC.
Regulatory Requirements:
- Banks: Subject to stricter regulatory requirements, including maintenance of the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).
- NBFCs: Have different regulatory norms and are not required to maintain CRR and SLR, although they must adhere to other prudential norms set by the Reserve Bank of India (RBI).
Role and Functions:
- Banks: Offer a wide range of services including accepting deposits, providing loans, payment and settlement services, foreign exchange transactions, and more.
- NBFCs: Primarily focus on lending and investment activities. They provide financial services like asset financing, leasing, hire purchase, and microfinance, but with limited scope in deposit-related services.
Access to Central Banking Facilities:
- Banks: Have direct access to central banking facilities, such as the RBI’s liquidity adjustment facility.
- NBFCs: Typically do not have direct access to central bank refinancing or liquidity support facilities.
In summary, while both banks and NBFCs play critical roles in the financial sector, they operate under different regulatory frameworks and offer distinct services. Banks provide comprehensive financial services, including deposit and payment facilities, while NBFCs primarily focus on lending and investments.
What are the different types of NBFCs registered with RBI?
Here are several types of NBFCs in India, along with their contributions to the country’s financial landscape:
1. Asset Finance Companies (AFCs)
An Asset Finance Company (AFC) is a type of Non-Banking Financial Company (NBFC) that specializes in financing tangible assets like machinery, vehicles, and equipment. These companies cater to individuals, SMEs, and large corporations by offering customised financing solutions for acquiring essential assets.
Key Characteristics and Contributions:
- Primary Business: AFCs focus on financing physical assets that support productive or economic activities, such as automobiles, tractors, machinery, and equipment.
- Financial Criteria: To qualify as an AFC, at least 60% of its total assets and income must come from financing these real or physical assets.
- Services Offered: AFCs provide loans and lease options, helping businesses acquire assets to expand their operations and promote economic growth.
- Economic Impact: By facilitating asset acquisition, AFCs play a vital role in industrial development and economic expansion, enabling businesses to increase their productivity and capacity.
Overall, Asset Finance Companies are crucial in supporting businesses to invest in key assets, fostering growth and development across various sectors.
2. Infrastructure Finance Company (IFC)
An Infrastructure Finance Company (IFC) is a type of Non-Banking Financial Company (NBFC) that funds infrastructure projects in sectors like power, roads, telecommunications, and transportation.
Key Characteristics and Contributions:
- Asset Deployment: At least 75% of assets must be in infrastructure loans.
- Financial Criteria:
- Minimum Net Owned Funds of ₹300 crore.
- Minimum credit rating of ‘A’ or equivalent.
- Capital to Risk (Weighted) Assets Ratio (CRAR) of 15%.
- Services Offered:
- Provides long-term loans and project-specific funding.
- Economic Impact:
- Facilitates economic progress and enhances quality of life by financing critical infrastructure projects.
3. Loan Companies (LC)
Loan Companies (LC) are key players in consumer finance, offering personal, home, and education loans, as well as credit for businesses through working capital, trade finance, and project financing. They serve customers with specific financial needs or limited access to formal credit channels, filling the gap left by traditional banks.
Key Characteristics:
- Primary Business: LCs provide finance through loans or advances for activities other than their own, excluding Asset Finance Companies.
- Services Offered: Personal and business loans, including working capital and project financing.
- Economic Impact: Enhance access to credit for individuals and businesses, supporting economic growth.
Loan Companies are crucial in providing tailored financial solutions to meet the diverse needs of their customers.
4. Investment Company (IC)
Investment Companies (ICs) primarily acquire and manage financial assets like stocks, bonds, mutual funds, and securities. They cater to both retail and institutional investors, offering investment opportunities across various asset classes. Through their expertise, ICs contribute to capital formation, mobilize funds for productive use, and promote responsible investing practices.
Key Characteristics:
- Primary Business: The main focus of an IC is acquiring securities.
- Services Offered:
- Management of financial assets.
- Facilitation of investment opportunities for investors.
- Economic Impact:
- Contribute to capital formation and mobilize funds.
- Encourage responsible investing and support financial market development.
Investment Companies are crucial in providing investment avenues and promoting efficient allocation of resources in the economy.
5. Systemically Important Core Investment Company (CIC-ND-SI)
Systemically Important Core Investment Companies (CIC-SIs) are a subset of NBFCs that primarily acquire shares and securities. These companies hold at least 90% of their total assets in investments in the equity shares, debt, or other financial assets of their group companies. Due to their potential impact on financial stability, CIC-SIs are closely regulated and supervised by the Reserve Bank of India (RBI).
Key Characteristics:
- Primary Business: Acquiring shares and securities is the main activity of CIC-SIs.
- Financial Criteria: They must hold at least 90% of their total assets in investments in their group companies.
- Systemic Importance: CIC-SIs are important for the financial system’s stability.
Systemically Important Core Investment Companies play a vital role in the financial system by strategically investing in their group companies’ assets, contributing to economic growth and stability.
How does an NBFC company work?
Non-banking financial companies (NBFCs) raise funds through deposits, loans, or other financial instruments, excluding traditional demand deposits. They lend to individuals, businesses, or other entities, often focusing on specific sectors or niches, and earn revenue through interest on loans, fees, and other financial services.
Key Operations:
- Fund Acquisition: NBFCs obtain funds from various sources like banks, financial institutions, retail investors, and capital markets.
- Lending Activities: Funds acquired are used to provide credit to borrowers in the form of loans and advances, with interest rates typically higher than those of banks.
- Revenue Generation: The difference between the borrowing cost and lending rate is the primary source of income for NBFCs.
- Regulatory Compliance: NBFCs must maintain a minimum net owned fund (NOF) and comply with regulatory guidelines such as the capital adequacy ratio (CAR) and asset-liability management (ALM) prescribed by the Reserve Bank of India (RBI).
- Regulation and Supervision: The RBI regulates NBFCs through periodic inspections, on-site examinations, and off-site surveillance.
- Diversification: NBFCs offer services like insurance, leasing, and hire-purchase to diversify revenue streams and reduce dependence on interest income.
- Customised Financial Solutions: NBFCs provide tailored financial solutions to meet the specific needs of their customers.
NBFCs play a vital role in complementing traditional banking services by catering to a diverse range of financial needs and providing access to credit for individuals and businesses.
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Conclusion
NBFCs are integral to the Indian financial system, providing vital credit to individuals and businesses. They raise funds from various sources, lending to specific sectors and earning revenue through interest and fees. NBFCs comply with RBI regulations, offering diverse financial services to reduce reliance on interest income. They complement traditional banking services, contributing significantly to economic growth by meeting diverse financial needs.
Emerging as crucial players, NBFCs provide credit to sectors ignored by traditional banks, promoting financial inclusion for low-income households and small businesses. With rising credit demand, NBFCs are expected to play a substantial role in India’s future economic growth.
