This article has been written by Apeksha Choubey, pursuing a Diploma in US Corporate Law for Company Secretaries and Chartered Accountants at LawSikho and edited by Shashwat Kaushik.
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Non-Banking Financial Companies (NBFCs) are an indispensable part of the Indian financial market and play a considerable role in the Indian economy. As their name suggests, their nature of operations is altogether different from that of banks. They provide services to mainly rural and semi-urban sectors. Through this article, we will try to gain a basic understanding of NBFCs under the headings below
What are NBFCs
A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 or the Companies Act, 2013, NBFCs, or non-banking financial companies, are financial institutions that provide a wide range of banking services and financial products, similar to traditional banks, but they do not hold a banking licence. These companies are an integral part of the financial system and play a crucial role in providing credit and financial services to various sectors of the economy.
NBFCs are financial institutions engaged in providing various financial services and products, with the principal business of receiving deposits under an arrangement in one lump sum, in instalments by way of contributions or in any other manner. But unlike banks, they cannot accept deposits from the general public and are not involved in the general banking business. These institutions provide varied services to their customers.
How is it different from banks
NBFCs perform normal lending and investment business like banks; however, there are three major differences between banks and NBFCs, as follows:
- NBFC cannot accept demand deposits,
- NBFCs are not allowed to issue cheques drawn facility and also cannot follow regular payment and settlement system,
- NBFC depositors cannot avail themselves of the facility of deposit insurance,
- Diverse financial services provided by NBFCs,
- Loans under different categories, such as personal, home, vehicle, and gold,
- Microfinance for small industries,
- Leasing and hire-purchase services,
- Credit cards and services,
- Insurance services,
- Investment services, and
- Asset management services.
Governance authority and registration requirements
The Reserve Bank of India (RBI) is the governing authority that issues licences to NBFCs, regulates their operations and ensures that they comply with laws and regulations while doing business. A company registered under the Companies Act, 1956, that wishes to commence its business as an NBFC specified under Section 45-I(A) of the Reserve Bank of India Act, 1934, should satisfy the following two conditions:
- Register under Section 3 of the Companies Act, 1956.
- Minimum Net Owned Fund (NOF) requirement of INR 200 lacs. There is a separate NOF requirement for specialised NBFCs such as NBFC-MFIs and CICs.
Different types of NBFCs
The different types of NBFCs are:
- Asset Finance Company (AFC)- These provide finance to purchase physical assets such as automobiles, vehicles, lathe machinery, generator sets, earthmoving and material handling equipment, etc. to support productive and economic activities.
- Investment Company (IC)- They invest in various securities such as stocks,bonds and debentures.
- Loan Company (LC)- These NBFCs provide loans or advances to individuals and businesses.
- Infrastructure Finance Company (IFC)- These companies provide long term finance to infrastructure schemes and satisfy the following criteria:
- Utilise at least 75% of its total assets in infrastructure loans.
- The minimum NOF required is Rs. 300 crore.
- The credit rating should be at least an A or equivalent.
- Capital-to-risk weighted assets ratio (CRAR) of 15%.
- Infrastructure Debt Fund- Non- Banking Financial Company (IDF-NBFC)- These NBFCs provide long term debt financing for infrastructure projects. IDF-NBFC raises resources through the issuance of Rupee or Dollar denominated bonds of a minimum 5 year maturity. Only Infrastructure Finance Companies (IFC) can sponsor IDF-NBFCs.
- Non-Banking Financial Company- Micro Finance Institution (NBFC-MFI)- These NBFCs are non deposit taking finance companies with at least 85% of their assets in the nature of qualifying assets and the minimum NOF is 5 crores.
- Non-Banking Financial Company-Factors (NBFC-Factors)- Their main line of business is factoring, which refers to financial transactions in which the company sells its bill receivables to third parties at a discounted rate.
- Mortgage Guarantee Companies (MGC)- This is another kind of NBFC where minimum 90% of the business turnover or minimum 90% of the gross income pertains to mortgage guarantee business with NOF Rs. 100 crores.
- NBFC- Non-Operative Financial Holding Company (NOFHC)- The promoter or promoter group will hold the bank as well as all other financial services companies that are regulated by the RBI or other financial sector regulators, to the extent permissible under the applicable regulatory prescriptions.
Functions of NBFCs
The functions of NBFCs are:
- The majority of NBFCs provide funds for infrastructure projects, including Railways, metro construction, Flyovers, Airports, Real estate, etc., which are considered the backbone of every developing country like India.
- Another major role is played in Hire Purchase services, through which the seller only delivers goods to the buyer and transfers ownership of the goods later, once full payment is made for the goods.
- They deal with Retail funding for many companies, which includes a variety of short-term loans against movable properties such as shares, gold, and property for various business purposes.
- They are also involved in the asset management function, where fund managers invest in the share market through pooling of funds from small investors and manage them to provide high rates of return.
- They fulfil the working capital requirements of companies for operating day to day business.
- Venture Capital funding is one of the major functions where they invest in small businesses at their initial stages to act as guarantors and help earn high profits from these projects.
- They provide finance and support Micro Small Medium Enterprises (MSME) registered under various schemes run by the Government to promote social and economic welfare for the country.
Key regulations for acceptance of deposits by the NBFCs
- To accept or renew public deposits for a minimum of 12 months and a maximum of 60 months.
- They are not allowed to accept deposits that are repayable on demand.
- They cannot charge interest rates higher than the ceiling rate prescribed by the RBI.
- They are not allowed to offer gifts or other benefits to the depositors.
- They should achieve a minimum investment grade credit rating.
- Their deposits are not insured.
In conclusion, NBFCs provide financial support for the expanding needs of both corporate and unorganised sectors, and they are rapidly expanding despite the global economy’s slowdown. They have become more popular in recent years due to their flexible lending policies and focus on customer service.
Given that NBFCs have become increasingly important to the growth of the economy and financial sector over the past few years, our Indian government has been concentrating on their development constantly. They receive a variety of forms of assistance in order to develop and broaden their presence in the expanding economy. These programmes include tax breaks, easier access to funding, and regulatory changes aimed at fostering an environment that is more favourable for NBFCs to operate in. Due to the fierce competition they face from banks, they must constantly find new sources of funding. Since they are unable to use low-cost deposits, they must obtain funding from debt and equity sources. To address these challenges, the RBI has implemented several measures to regulate NBFCs in India. These measures include stricter capital adequacy requirements, a more comprehensive regulatory framework, and increased disclosure requirements. The RBI has also introduced a mechanism for monitoring systemic risks associated with NBFCs.