Non-Banking Financial Companies (NBFCs)

A Non-Banking Financial Company (NBFC) is a financial institution registered under the Companies Act, 1956 (now Companies Act, 2013). It is engaged in lending, providing advances, leasing, hire-purchase, insurance services, and acquiring financial securities such as shares, stocks, bonds, and debentures. However, it does not include institutions whose primary business is agriculture, industrial activities, trading in goods other than securities, providing services, or dealing in immovable property. A special category of Residuary Non-Banking Companies exists, where the principal business is to receive deposits under schemes or arrangements, either in lump sum or in installments.

Features of NBFCs

• NBFCs perform functions similar to banks but are not the same as banks. They cannot accept demand deposits and are not part of the payment and settlement system, which means they cannot issue cheques drawn on themselves. Depositors of NBFCs do not enjoy the protection of deposit insurance provided by the Deposit Insurance and Credit Guarantee Corporation (DICGC). Generally, NBFCs are permitted to accept only time deposits ranging between twelve months and sixty months. They are also restricted from offering interest rates higher than the ceiling fixed by the Reserve Bank of India, which is presently 12.5 percent per annum. In addition to lending and investments, NBFCs also provide financial advice and services such as chit-reserves and advances.

NBFCs and Banks: A Comparison

• Although NBFCs engage in financial intermediation like banks, they operate under different rules. NBFCs do not hold a banking license, cannot accept demand deposits, and are not included in the payment system. Unlike banks, NBFCs cannot issue cheques and are not covered by deposit insurance facilities of DICGC. Moreover, while banks are subjected to stringent regulatory norms, NBFCs are comparatively less regulated.

Regulation of NBFCs

• The regulation of NBFCs is shared by the Ministry of Corporate Affairs and the Reserve Bank of India. The RBI has the authority to grant licenses, monitor operations, and enforce compliance with prudential norms. Other regulators also oversee specific financial institutions: housing finance institutions are supervised by the National Housing Bank, merchant banking and venture capital funds by the Securities and Exchange Board of India (SEBI), insurance companies by the Insurance Regulatory and Development Authority of India (IRDAI), chit fund companies by state governments, and Nidhi or mutual benefit companies by the Ministry of Corporate Affairs.

Classification of NBFCs

• NBFCs can be classified on the basis of their activities, liabilities, and size. Activity-wise, NBFCs include asset finance companies, investment companies, loan companies, infrastructure finance companies, core investment companies, infrastructure debt funds, microfinance institutions, NBFC-factors, mortgage guarantee companies, and non-operative financial holding companies. On the basis of liabilities, they are divided into deposit-taking and non-deposit-taking NBFCs. Among the non-deposit-taking institutions, those with asset size of ₹500 crore or more are designated as systemically important NBFCs, while others are categorized as non-deposit holding NBFCs.

Systemically Important NBFCs

• Systemically important NBFCs are those with assets worth ₹500 crore or more, according to the last audited balance sheet. The classification has been introduced because such institutions, due to their size and activities, have a significant impact on the stability of the overall financial system. Consequently, they are subjected to closer monitoring and tighter regulation.

Examples of NBFCs

• Examples of NBFCs include investment banks, mortgage lenders, money market funds, insurance companies, infrastructure finance companies, equipment leasing companies, private equity funds, hedge funds, and peer-to-peer lending platforms.

Benefits of NBFCs

• NBFCs contribute significantly to the financial system by promoting financial inclusion, providing innovative products, ensuring liquidity in the economy, and supporting the growth of Micro, Small, and Medium Enterprises (MSMEs).

Challenges of NBFCs

• Despite their importance, NBFCs face several challenges. These include funding constraints, deterioration in asset quality, exposure to credit risks, regulatory compliance burdens, and corporate governance issues.

Deposit Insurance and Credit Guarantee Corporation (DICGC)

• The Deposit Insurance and Credit Guarantee Corporation is a wholly owned subsidiary of the Reserve Bank of India. It provides insurance cover for bank deposits up to ₹5 lakh per depositor per bank, covering savings, current, recurring, and fixed deposits. If deposits exceed this limit, only ₹5 lakh, including principal and interest, is insured in the event of bank failure. NBFC deposits, however, are not insured under the DICGC scheme, which makes them inherently riskier for depositors.