Non-Banking Financial Company (NBFC) – Indian Economy Notes

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 that is engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business, but does not include any institution whose primary business is agriculture, industrial activity, purchase or sale of real estate.

A non-banking institution company is a company that receives deposits under any scheme or arrangement in one lump sum or in installments by way of contributions or in any other manner is also a non-banking financial company(Residuary non-banking company).

What is NBFC?

• A non-banking financial company, also known as a non-banking financial institution, provides financial services and products but is not recognised as a bank with a full banking licence.
• NBFCs are not banks, but their activities include lending and other activities such as providing loans and advances, credit facilities, savings and investment products, trading in the money market, managing stock portfolios, money transfers, and so on.
• NBFC Registration is required before NBFC activities can begin.
• Their activities include hiring, leasing, infrastructure finance, venture capital finance, housing finance, and so on.
• Deposits can be accepted by NBFC, but only term deposits and deposits repayable on demand is not accepted.
• Some examples of well-known NBFCs are Kotak Mahindra Finance, SBI Factors, Sundaram Finance, and ICICI Ventures.

Criteria for NBFC License

• The company must be registered in accordance with the Companies Act.
• The corporation should be either a Limited Company or a Private Limited Company (PLC).
• The company's Net Owned Fund must be at least Rs. 2 crores.
• Following NBFCs are exempted from the requirement of registration with RBI:
  • Venture Capital Fund / Merchant Banking companies / Stockbroking companies registered with SEBI.
  • Insurance Company holding a valid Certificate of Registration issued by IRDA.
  • Nidhi companies as notified under Section 620A of the Companies Act, 1956.
  • Chit companies as defined in clause (b) of Section 2 of the Chit Funds Act, 1982.
  • Housing Finance Companies regulated by National Housing Bank.
  • Stock Exchange or a Mutual Benefit company.

Types of NBFCs

The NBFCs can be categorised under three broad heads:

1. On the nature of their activity
2. On the basis of deposits
3. On the basis of their assets size

The different types of Non-Banking Financial Corporations or NBFCs are as follows:

On the basis of deposits

• Deposit accepting Non-Banking Financial Corporations
• Non-deposit accepting Non-Banking Financial Corporations

On the basis of their assets size

• Systematically Important NBFCs
• Non-systematically Important NBFCs

On the nature of their activity

• Asset Finance Company (AFC)
• Loan Company (LC)
• Mortgage Guarantee Company (MGC)
• Investment Company (IC)
• Systematically Important Core Investment Company (CIC-ND-SI)
• Infrastructure Finance Company (IFC)
• Non-Banking Financial Company: Micro Finance Institutions (NBFC-MFI)
• Infrastructure Debt Fund: Non-Banking Financial Company (IDF-NBFC)

• Non-Banking Financial Company-Factors (NBFC-Factors)
• NBFC-Non-Operative Financial Holding Company (NOFHC)

Difference Between Banks and NBFC

Regulation of NBFCs

• The RBI's Department of Non-Banking Supervision (DNBS) is tasked with regulating and supervising NBFCs in accordance with the regulatory provisions contained in Chapters III B and C and Chapter V of the Reserve Bank of India Act, 1934.
• The Reserve Bank's Regulatory and Supervisory Framework provides for, among other things, registration of NBFCs, prudential regulation of various categories of NBFCs, the issuance of directions on the acceptance of deposits by NBFCs, and sector surveillance through off-site and on-site supervision.
• Deposit-taking NBFCs and Systemically Important Non-Deposit Accepting Companies face increased regulation and supervision.
• The three main goals of regulation and supervision are as follows:
  • depositor protection
  • consumer protection
  • financial stability.
• In extreme cases, the RBI is also empowered under the RBI Act 1934 to take punitive action, such as:
  • cancelling a Certificate of Registration, issuing prohibitory orders against accepting deposits, filing criminal cases, or filing winding-up petitions under the provisions of the Companies Act.
• The Reserve Bank of India (RBI) recently proposed a tighter regulatory framework for Non-Banking Financial Companies (NBFCs) by establishing a four-tier structure with a progressive increase in regulatory intensity.
• It has also proposed reducing the classification of non-performing assets (NPAs) of base layer NBFCs from 180 to 90 days overdue.
• The proposed framework is intended to protect financial stability while allowing smaller NBFCs to continue to operate under light regulations and grow with ease.

NBFC – Significance

• NBFCs play an important role in developing countries like India, where access to bank finance remains a challenge for a large portion of the population and businesses.
• Nonbanking financial institutions, including NBFCs in India, provide services to market segments that commercial banks do not serve due to higher risk and lower returns.
• Nonbanking financial institutions are an essential part of an economy's financial sector due to their inherent characteristics.

NBFC – Criticism

• The fact that NBFCs are not as heavily regulated as banks adds to the risk. Such a risk was highlighted during the 2008 Global Financial Crisis, when companies' lending practises went unchecked, resulting in a disastrous outcome.
• The IL&FS default and subsequent turbulence in the Indian credit markets in 2018 raised some critical and fundamental questions about the role of NBFCs, their business model, and the best regulatory regime for them.

Conclusion

Non-banking Financial Companies (NBFCs) have taken on new meaning in India and have experienced rapid growth in recent years. NBFCs are corporations that are not banks but carry out lending activities atpar with banks. They may also accept public deposits, but these are term deposits rather than call deposits.

FAQs

MCQs

1. Which of the following services is provided by an NBFC?

A. Issuing checks
B. Accepting demand deposits
C. Providing loans and advances
D. Participating in payments system

2. Which institution regulates NBFCs in India?

A. SEBI
B. RBI
C. IRDA
D. NITI Aayog

3. What distinguishes an NBFC from a bank?

A. NBFCs can accept demand deposits
B. NBFCs are involved in the payments system
C. NBFCs cannot issue checks
D. NBFCs are unregulated

4. Which of the following is a type of NBFC?

A. Commercial Bank
B. Microfinance Institution
C. Cooperative Bank
D. Regional Rural Bank

5. Which entity regulates microfinance institutions in India?

A. IRDA
B. SEBI
C. RBI
D. NITI Aayog

GS Mains Questions and Model Answers

1. Discuss the role of NBFCs in the Indian economy and their contribution to financial inclusion.

Answer: NBFCs play a pivotal role in India's financial system by providing credit and financial services to underserved sectors. They cater to small businesses, individuals in rural areas, and low-income groups that banks may not reach. NBFCs contribute to economic development by offering flexible credit solutions, supporting infrastructure projects, and enhancing financial inclusion through microfinance and asset financing.

2. Explain the regulatory challenges faced by NBFCs in India.

Answer: The key regulatory challenges NBFCs face include maintaining adequate capital reserves, managing liquidity risks, and complying with strict RBI norms. The IL&FS crisis highlighted issues with asset quality and governance, prompting the RBI to tighten regulations. The evolving regulatory framework aims to balance financial stability while ensuring NBFCs continue to support niche markets and underserved segments.

3. How do NBFCs differ from traditional banks in terms of their structure, regulation, and function?

Answer: NBFCs differ from banks as they cannot accept demand deposits or issue checks. They operate under lighter regulatory oversight but are critical in extending credit to small and medium enterprises (SMEs), infrastructure, and rural sectors. While banks are part of the payment system and offer a wider range of services, NBFCs are more flexible, focusing on specific market needs.

Previous Year Questions on NBFCs

1. UPSC CSE Prelims 2020

Question: What distinguishes an NBFC from a bank?
A. NBFCs can issue checks
B. NBFCs cannot accept demand deposits
C. NBFCs are regulated by SEBI
D. NBFCs are unregulated

Answer: B

Explanation: NBFCs cannot accept demand deposits or issue checks, distinguishing them from traditional banks.

2. UPSC CSE Mains 2019 (GS Paper 3)

Question: Analyze the significance of NBFCs in promoting financial inclusion in India.

Answer: NBFCs are crucial for financial inclusion, providing credit to small businesses, individuals in rural areas, and underserved sections of society. They fill the gap left by traditional banks, supporting economic development by offering flexible financial products tailored to the needs of low-income and marginalized communities.