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An Overview Of Non- Banking Financial Service Institutions

Non-Banking financial companies play an important role in access to financial services enhancing competition and diversification of the financial sector. There are various types of institutions to be involved in financial services in India. This includes commercial banks financial institutions and Non-banking finance companies due to the financial sector reforms Non-banking financial companies have been emerged as an integral part of the Indian financial system.

Nonbanking finance companies frequently act as suppliers of loans and credit facilities and accepting the deposits, operating various mutual funds, and similar other functions. They are competitive and complementary to banks and financial institutions. In this paper, the author will analyze various types of NBFCs, its benefits, the difference between the owned and net owned funds of NBFCs, and how are NBFCs different from Banks.

Introduction
NBFC is a Financial Institution that is into Lending or Investment or collecting monies under any scheme or arrangement but does not include any institutions which carry on its principal business as agriculture activity, industrial activity, trading and purchase or sale of immovable properties. A company that carries on the business of accepting deposits as its principal business is also an NBFC.

India has a diversified financial sector undergoing rapid expansion, both in terms of the strong growth of existing financial services firms and new entities entering the market. The sector comprises commercial banks, insurance companies, non-banking financial companies, co-operatives, pension funds, mutual funds, and other smaller financial entities. The banking regulator has allowed new entities such as payments banks to be created recently thereby adding to the types of entities operating in the sector.

An Overview Of Non- Banking Financial Service Institutions

However, the financial sector in India is predominantly a banking sector with commercial banks accounting for more than 64 percent of the total assets held by the financial system. The Government of India has introduced several reforms to liberalize, regulate and enhance this industry.[1]

The Government and Reserve Bank of India (RBI) have taken various measures to facilitate easy access to finance. These measures include (to name a few) launching different categories of Non-Banking Finance Companies (NBFCs), Asset Reconstruction Companies (ARCs), and Micro Finance Institutions (MFIs).

With a combined push by both government and private sector, India is undoubtedly one of the world’s most vibrant capital markets. Over the years, Non-Banking Financial Companies (NBFC’S), Housing Finance Companies (HFC’s), Asset Reconstruction Companies (ARC’s), Micro Finance Institutions (MFI’s), and Nidhi Companies have played a dominant role in mobilization and disbursal of funds.[2]/

With the advent of mobile technology and vast strides made by the country in the field of information technology, Payment Banks has emerged as a new model of banks conceptualized by the Reserve Bank of India (RBI).

Analysis
What is non-banking Financial Institutions (NBFIs)?
A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 2013[3] 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 principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of the immovable property.

A non-banking institution which is a company and has principal business of receiving 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).

Financial activity as a principal business is when a company’s financial assets constitute more than 50 percent of the total assets and income from financial assets constitute more than 50 percent of the gross income. A company that fulfills both these criteria will be registered as NBFC by RBI. Interestingly, this test is popularly known as the 50-50 test and is applied to determine whether or not a company is into financial business.[4] NBFCs lend and make investments and hence their activities are akin to that of banks; however, there are a few differences as given below:
  1. NBFC cannot accept demand deposits;
  2. NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on themselves;
  3. Deposit the insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in the case of banks.

In terms of Section 45-IA of the RBI Act, 1934[5], no Non-banking Financial Company can commence or carry on the business of a non-banking financial institution without a) obtaining a certificate of registration from the Bank and without having a Net Owned Funds of Rupees Two crore.

However, in terms of the powers given to the Bank, to obviate dual regulation, certain categories of NBFCs which are regulated by other regulators are exempted from the requirement of registration with RBI viz. 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 or formed under section 406 of the Companies Act, 2013[6], Chit companies as defined in clause (b) of Section 2 of the Chit Funds Act, 1982[7], Housing Finance Companies regulated by National Housing Bank, Stock Exchange or a Mutual Benefit company.

Various Types of NBFCs

NBFCs are categorized as above:
  1. In terms of the type of liabilities into Deposit and Non-Deposit accepting NBFCs,
  2. Non deposit taking NBFCs by their size into systemically important and other non-deposit holding companies (NBFC-NDSI and NBFC-ND) and
  3. By the kind of activity they conduct.


Within this broad categorization the different types of NBFCs are as follows[8]:

  1. Asset Finance Company (AFC):
    An AFC is a company which is a financial institution carrying on as its principal business the financing of physical assets supporting productive/economic activity, such as automobiles, tractors, lathe machines, generator sets, earth moving and material handling equipment, moving on own power and general purpose industrial machines. Principal business for this purpose is defined as the aggregate of financing real/physical assets supporting economic activity and income arising therefrom is not less than 60% of its total assets and total income respectively
     
  2. Investment Company (IC):
    IC means any company which is a financial institution carrying on as its principal business the acquisition of securities
     
  3. Loan Company (LC):

    LC means any company which is a financial institution carrying on as its principal business the providing of finance whether by making loans or advances or otherwise for any activity other than it's own but does not include an Asset Finance Company.
     
  4. Infrastructure Finance Company (IFC):

    IFC is a non-banking finance company:
    1. Which deploys at least 75 percent of its total assets in infrastructure loans,
    2. Has a minimum Net Owned Funds of Rs 300 crores,
    3. Has a minimum credit rating of ‘A’ or equivalent
    4. And a CRAR of 15%. Capital adequacy ratio of banks capital to its risk.
       
  5. Systemically Important Core Investment Company (CIC-ND-SI): CIC-ND-SI is an NBFC carrying on the business of acquisition of shares and securities
     
  6. Non-Banking Financial Company - Micro Finance Institution (NBFC-MFI):

    It means a non-deposit taking NBFC (other than a company formed and registered under section 25 of the Companies Act, 1956 or Section 8 of the Companies Act, 2013) that fulfills the following conditions:
    1. Minimum Net Owned Funds of Rs 5 crores. (For NBFC-MFIs registered in the North Eastern Region of the country, the minimum NOF requirement shall stand at Rs 2 crores).
    2. Not less than 85% of its net assets are in the nature of “qualifying assets.”

Benefits of NBFCs

According to research and studies, it is proved that NBFCs are outperforming banks. The continued better performance from NBFCs has given rise to an uptick of 15% customer satisfaction as compared to the banking customers. The same is agreed by the RBI according to the recent Financial Stability Report. Banks and Non- Banking Financial Companies (NBFCs) are financial intermediaries and the services offered by them are pretty much the same as banks.

However, the benefits of incorporating an NBFC and carrying on its activities are listed below[9]:

  1. Competitive Interest Rates:
    Rate of interest is one of the main aspects of all types of loans. Non-Banking Financial Sectors have started to concentrate on this area in the recent decades and have brought down the interest rates to either equal to bank lending rates or at times even lower to bank rates. With all the other benefits when the rate of interest is also lowered, borrowers found this more easy and affordable. This has also resulted in lower EMI (Equated Monthly Instalment) for borrowers. Based on the income, credit scoring, and repayment, the rate of interest is charged on the borrowers However it is at competitive rates.
     
  2. Quick Processing:
    At banks, it is very important that the applicant should fulfill the eligibility criteria but NBFC is lenient in this aspect. This makes loan approval easier, a smoother process, and quicker. Most of the time, people apply for loans when they are in immediate need of money. NBFCs have taken this as an opportunity to meet the demand by quickly processing the loans at a competitive rate of interest. At times, borrowers are even ready to compromise on the interest rates if the loan amount is huge and if they could get it approved quickly.
     
  3. Fewer Rules and Regulations:
    As NBFC is incorporated under the Companies Act, (though regulated by the Reserve Bank of India), the rules and regulations for lending are not as stringent as banks. This helps borrowers to get loans easily. In view of less complicated loan processing requirements, borrowers are highly satisfied. Of course, the risk of default is high with NBFC and thus interest rates and other charges will be according priced by the NBFC. Even the loan amount approved will be quite lesser than the collateral value. This is due to the high risk of default. NBFCs do not have statutory reserve ratios and can open branches at will.
     
  4. Loan available for Individuals with Poor Credit Rating:
    Individuals with poor credit ratings generally will not get loans from banks. The reason for this is banks consider borrowers are high-risk individuals if the credit scoring is low. Unless the credit score is above 600 -650, it is very difficult to get a loan sanctioned from banks. On the other hand, loans will be offered to individuals with low credit scores by NBFCs but most of the time the interest rates for such borrowers will be higher than market rates. Due to these aforementioned advantages, most of the NBFCs are growing.
     
  5. With regard to offering loans, banks and NBFCs will offer business, personal and retail loans. And this is totally on the basis of the repayment capacity of the borrower. Most of the corporate sector prefers banks; however retail sector chooses NBFCs over banks. Simple loans such are vehicle financing loans, gold loans, home loans, and durable loans are offered by NBFCs and the customer satisfaction ratio is high here. NBFC sector is also set to expand even further in the coming days.

How is the bank different from NBFIs?

NBFIs lend and make investments and hence their activities are similar to that of banks; however there are a few differences:
  1. NBFC cannot accept demand deposits;
  2. NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on themselves;
  3. the deposit insurance facility of Deposit Insurance and Credit Guarantee the corporation is not available to depositors of NBFCs, unlike in the case of banks.[10]

Here are some of the key points which shows the different functioning of NBFCs than that of Banks[11]:

  1. Governing Act:
    Banking companies are governed by Banking Companies Act, 1949, whereas, Non-banking Financial companies are governed by RBI Act
  2. License:
    Banking companies must obtain a license from RBI for commencement. However, there is no license is required in the case of NBFCs.
  3. Ceiling on deposits:
    There is no ceiling on deposit mobilization in the case of a banking company, on the other hand in the case of for NBCs there is a restriction on acceptance of deposits which is based on the net worth of the company.
  4. Balance Sheet:
    The proforma for the Balance sheet of the banking company should be as per the format provided by RBI. But for Non-banking The company, the balance sheet should be as per the Companies Act.
  5. Negotiable instruments:
    There is the use of negotiable instruments such as cheques, bills of exchange for various transactions in a bank. But Negotiable instruments cannot be used for the withdrawal of money from Non-Banks.
  6. Credit Rating:
    Credit rating is not required for accepting deposits in the case of a banking company. Whereas NBFCs have a mandatory requirement of Credit rating in order to accept deposits from the public
  7. Types of Accounts:
    Different types of accounts can be opened by a bank for the benefit of customers in a banking company. A non-banking financial company can only accept deposits of different duration as prescribed by RBI.
  8. Interest on deposit:
    The interest charged by a bank` on deposits is decided by the banks themselves. It is based on Prime Lending Rate (it is the interest rate charged by the banks while lending on Government securities that have no risks). But for a non-banking company, the interest rate on deposits is decided by RBI.
  9. Insurance coverage on deposit:
    All bank deposits are insured up to a certain limit compulsorily with Deposit Insurance Credit Guarantee Corporation. But there is no insurance cover for non-banking company deposits.
  10. Lending policy:
    The lending policy of commercial banks is influenced by the monetary policy of RBI. But for the other institutions, the lending policy is decided by the security offered by the borrower
  11. Joint Operation:
    All banking companies are necessarily joint-stock companies. But, NBFCs can be in the form of Nidhis, Benefit societies, etc. However, partnership firms are prohibited now.
  12. Forex Transaction:
    The commercial banks can undertake transactions in foreign exchange as Authorized Dealers, whereas, NBFCs cannot undertake transactions in foreign exchange unless they are licensed by RBI.
  13. Merger of banks:
    A banking company can be merged with other commercial banks as per RBI orders. But the Merger of non-banking will be as per the Companies Act.
  14. Periodical Inspection:
    There can be an inspection of banks by RBI periodically. No such approval is required from RBI. But, non-banks should comply with the provisions of the Companies Act.
  15. Appointment of Chairman and Directors:
    Appointment of Chairman and managing directors in a banking company requires prior approval of RBI. But no such approval is required from RBI for an NBC. But, they should comply with the provisions of the Companies Act.
  16. Public Sector:
    There exists a public sector commercial bank in India. But there does not exist public sector non-banking companies
  17. Type of Advertisements:
    Commercial banks can choose any type of advertisement for inviting public deposits. For non-banks, advertisements for inviting public deposits should be as per RBI regulations.
  18. Customer grievance:
    For a banking company, consumers’ Grievance Cells of respective banks will look after the grievance of customers. Whereas in the case of NBFCs a Company Law Board is set up which acts as the regulatory authority for non-banking companies in case of non-refund of deposits.
  19. Rate of Interest:
    Consumer credit is cheaper with banks as the interest charged is on a declining rate of interest. But hire purchase finance of NBFCs has a flat rate of interest and hence it’s costlier.
  20. Evidence between banker and customer:
    Savings account and current account are operated in a bank and entries of the savings account are recorded in the passbook and the passbook is regarded as the conclusive evidence between a banker and customer. But there are no such accounts in non-banking companies.[12]

Conclusion
In India, both the Banks and the NBFIs are the key elements of a sound and stable financial system. Usually the Banking Institutions dominate the financial system in most countries including India because every sector whether business, household or the public, all collectively rely on the banking system for a wide range of activities and to meet their financial needs.

Nevertheless, by offering all the additional and alternative financial needs along with the usually required needs of the people, NBFIs have also gained significant popularity in both the developed & developing countries. The NBFCs on the one hand facilitates long term investment and financial services and provides aid to the people who requires such a facility but are unable to because of a lot of formalities and limitations in the banking sector, it is often a challenge to the banking sector. Whereas, on the other hand, there is a growth of NBFIs with a wide range of products available for individuals & institutions with the available resources to invest.

NBFIs not only provides demand side of fund an alternative sector of financing besides bank financial institution but also facilitate a sound competitive environment in the financial market. Therefore, the role of NBFIs have also become very important especially today.

References
  • https://accountlearning.com/banking-company-vs-non-banking-company-including-nbfcs/
  • https://vikaspedia.in/social-welfare/financial-inclusion/financial-literacy/non-banking-financial-companies
  • https://www.rbi.org.in/Scripts/FAQView.aspx?Id=92
  • https://www.researchgate.net/publication/335544028_PERFORMANCE_OF_NON-BANKING_FINANCIAL_INSTITUTIONS_IN_INDIA
  • https://rbidocs.rbi.org.in/rdocs/Bulletin/PDFs/01AR101017F2969F6115EB4B5992BD73976F9A905D.PDF
  • https://www.icsi.edu/media/portals/86/manorama/DBIMS%20Journal%20.pdf
End-Notes
  1. Swarit Advisors, Non -Banking Financial Companies (NBFC)- An overview https://swaritadvisors.com/learning/non-banking-financial-companies-nbfc-an-overview/ (accessed on 09/03/2021 at 05.13 pm).
  2. Ibid.
  3. The Companies Act, 2013.
  4. RBI Government, https://www.rbi.org.in/Scripts/FAQView.aspx?Id=92 (accessed on 09/03/2021 at 05.15 pm
  5. RBI Act, 1934, s 45-IA.
  6. Companies Act, 2013, s 406.
  7. Chit Funds Act, 1982, cl (b) s 2.
  8. N Gopal Swamy, Dr. M. Nandhini, Performance of Non- Banking Financial Institutions in India. https://www.researchgate.net/publication/335544028_PERFORMANCE_OF_NON-BANKING_FINANCIAL_INSTITUTIONS_IN_INDIA (accessed on 09/03/2021 at 05.03pm)
  9. Ibid
  10. Ibid
  11. Account Learning, Banking company v. Non-banking company (including NBFCs) https://accountlearning.com/banking-company-vs-non-banking-company-including-nbfcs/ (accessed on 09/03/2021 at 05.22 pm)

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