What Is NBFC

What is NBFC

  • An NBFC is a special company providing financial facilities but is still termed as Non-Banking Financial Company. The principal business of NBFC can be giving loans and advances, leasing, hire-purchase, insurance business, chit-fund business, acquisition of shares, bonds, debentures, stocks, and Government or local authority bonds/ securities which are marketable in nature, etc.

What is NBFC in India

As per the Companies Act 2013, Non-Banking Financial Company or NBFC is a type of company engaged in the business of receiving Loans and Credit Facilities, Acquisition of Bonds, Stocks or Shares, Hire-Purchase, Leasing, Insurance, Assets Financing, Currency Exchange, Peer to Peer Lending, Hedge Funds, Chit Business, etc. So let’s see what is NBFC, as under the Companies Act, and, according to rules & regulations given in Section 45-IA of the RBI Act 1934.

Those companies that are in the business of:

    • Loans and advances,
    • Investments in stock/equity/shares/bonds/debentures and other Govt securities,
    • Hire-purchase,
    • Chit fund,
    • Lease,
    • Insurance business,

can become NBFCs.

But they cannot be engaged in:

    • Agricultural activity,
    • Industrial activity,
    • Purchase/sale of any goods and services (except securities), and
    • Sale/purchase/construction of an immovable property.

NBFCs provide various banking and non-banking services to the concerned people. They do not hold banking license but their functions are regulated and supervised by RBI according to the provisions mentioned in Chapter III B of the RBI Act 1934. 

The primary business activity of the NBFCs is to raise capital funds from public depositors and investors and then lend. NBFCs are an alternative to the banking and financial sector. 

Though their financial activities are somewhat similar to banks, however, there are many differences between the two. For instance, the deposits in NBFC are not insured. Unlike banks, NBFC cannot accept demand deposits or issue cheques. 

Difference between NBFCs and Banks

Let’s check what is the difference between the activities of an NBFC and a Bank, in detail, here. Banks and NBFCs differ in the following ways:

    • NBFC is incorporated under the Companies Act whereas banks are registered under the Banking Regulation Act, 1949.
    •  Not all NBFCs are allowed to accept deposits that are repayable on demand whereas banks are allowed to accept such deposits. Only those NBFCs are allowed that have been pre-approved by the RBI to accept these deposits, upon its application specifying the need.
    • The NBFC, unlike banks, is not part of the payment and settlement system. It cannot issue cheques to its customers, drawn on itself.
    • Unlike banks, the insurance facility on deposits by DICGC (Deposit Insurance and Credit Guarantee Corporation) is not available for NBFC depositors.
    • In NBFC, foreign Investments of up to 100% is allowed. Whereas in the case of private sector banks they are eligible for foreign investment of up to 49%. They may get this limit increased to 74% by getting approval from the government. And this limit in public sector banks is 20%.
    • Banks must maintain reserve ratios like CRR or SLR. This is not mandatory for NBFCs.
    • Banks can create credit but NBFCs cannot get involved in the creation of credit.
    • Banks can provide transaction services to its customers such as providing overdraft facility, transfer of funds, issue of traveler’s cheque, etc. NBFCs are not authorized to provide these facilities.
    • The sector which is being looked after by the NBFCs is more towards the unorganized one. That has a low or no credit rating score. Unlike banks.

Types of NBFCs

Basically, NBFCs can be classified broadly under either of these 2 categories:

    1. The Deposit Accepting NBFC.
    2. Non-Deposit accepting NBFC.

The Deposit Accepting NBFCs

Deposit accepting firms are required to get themselves registered with RBI as per the regulations laid down in the RBI Act, 1934. NBFC’s need the certificate of registration from RBI and are required to follow specific regulations prescribed by RBI.

Non-Deposit Accepting NBFCs

Non-Deposit Accepting NBFCs also need to get registered themselves. The only difference between NBFC’s Accepting Deposits and NBFC’s Non-Accepting Deposit is that some additional guidelines are to be followed by the prior one, once registered.

Within the above broad categorization, the NBFCs can, further, be divided into

  • Asset Finance Company (AFC): An AFC is a financial institution that finances the physical assets as its principal business. It includes 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. 
  • Investment Company (IC): IC means any company which is a financial institution engaged in the acquisition of securities, as its principal business.
  • Loan Company (LC): LC is a financial institution, carrying on as its principal business, provision of finance. The activity is to make loans or advances or otherwise for any activity other than its own but does not include an Asset Finance Company.
  • Infrastructure Finance Company (IFC): IFC is an NBFC which:
    1. deploys at least 75% of its total assets in infrastructure loans,
    2. has a minimum NOF (Net Owned Funds) of Rs. 300 crores, 
    3. has a credit rating of minimum “A” or equivalent, and, 
    4. a CRAR of 15%. 
  • Systemically Important Core Investment Company (CIC-ND-SI): CIC-ND-SI is an NBFC engaged in the business of acquisition of shares and securities. The transactions must satisfy the following conditions:
    1. it holds not less than 90% of its Total Assets in the form of investment in equity or preference shares, and debt or loans in group companies, 
    2. its investments in the equity stock (including instruments that would convert into equity shares within a period not exceeding 10 years from the date of issue, compulsorily) in group companies forms not less than 60% of its Total Assets, 
    3. it does not trade in its investments in shares, debt or loans in group companies except through block sale for dilution or disinvestment,
    4. no financial activity is carried out by it, which are listed under Section 45I(c) and 45I(f) of the RBI Act, 1934. Except for investments in bank deposits, government securities, money market instruments, loans to and investments in debt issuances of group companies or guarantees declared on behalf of group companies, 
    5. its asset size is Rs 100 crore or more, and, 
    6. it accepts public funds. 
  • Infrastructure Debt Fund: IDF-NBFC is a company registered as NBFC to facilitate the flow of long term debt into infrastructure projects. IDF-NBFC raise resources through issue of Rupee or Dollar denominated bonds having a minimum maturity period of 5-years. Only IFC – NBFC can sponsor IDF-NBFCs. 
  • Micro Finance Institution (NBFC-MFI): NBFC-MFI is a non-deposit taking NBFC with at least 85% of its assets like qualifying assets that satisfy the following criteria: 
    1. loan disbursed by an NBFC-MFI to a borrower having a Rural Household Annual Income not exceeding Rs. 60,000, or Urban and Semi-Urban Household Income of not over Rs. 1,20,000.
    2. the loan amount does not exceed Rs. 35,000 in the first cycle and Rs. 50,000 in subsequent cycles
    3. total indebtedness of the borrower is not more than Rs. 50,000,
    4. loan duration of at least 24 months, if the amount is more than Rs. 15,000 with prepayment without penalty,
    5. loan to be extended without security,
    6. the aggregate amount of loans, given for income generation, is not less than 75% of the total loans given by the MFI,
    7. the loan is repayable on weekly, fortnightly or monthly instalments. The frequency to be selected by the borrower.

What is Scope of NBFC in India

NBFC sector in India has tremendous growth opportunities. These organizations are very relevant to the economy and that’s why their operations receive so much attention from the government and various regulators etc. The credit gap in India in the SME and at the bottom of the pyramid is quite significant. And this is where the NBFCs play an important role.

The industry has seen some low times in the past 1-2 years. So this is the time for the NBFCs to upgrade their business model. Digital technology is the way to go for them. With its help, the product portfolio, customer experience, etc. can be enhanced.

With internet connectivity increasing its foothold in rural and backward areas, the smartphone technology provides an opportunity to NBFCs to improve their networking and position their financial products prominently. They can use the customer data available on digital and social media platforms to improve sales strategies. The creditworthiness of large and untapped market segments can also be found online, which helps NBFCs in optimizing their business decisions. With the use of digital technology, NBFCs can better identify the individual, his intentions and the ability to repay loans. Credit risk can be decided by analyzing data from mobile bill payments, prepaid top-ups, browsing, and download history.

Online customer lending has grown tremendously in the past few years providing scope to NBFCs. NBFCs can increase customer satisfaction by putting online tools on their websites. Such as knowledge centers, calculators, live chats, and live application tracking system.

Advantages of NBFC

NBFCs are slowly becoming popular with the institutional investors because they provide semi-rural and rural India with access to credit. Following are the advantages of NBFCs in India-

    • There is much less paperwork and official procedure involved as compared to banks. So customers choose to approach NBFCs than other financial institutions.
    • It caters to all small and big businesses.
    • The NBFCs form a significant part of the financing industry. Being essential for the development of industrial, commercial, institutional and service sectors, the government takes an active interest in their functioning. Striving to provide facilities.
    • NBFCs are considered to have a customer-oriented approach.
    • The rate of interest charged by the NBFC is based on its own decision. The interest at which an NBFC can advance loan can be decided by the NBFC itself. It has the liberty to charge a high-interest rate on short-term lending, subject to a ceiling cap by the RBI.
    • NBFCs are considered easier to approach by the customers. And have a handful of hassle-free services. Such as they support investment in property, help in trading money market instruments, fund private education, provide retirement planning.
    • Not only individual clients, but business organizations prefer to work with the NBFCs as well. Because they advise companies on mergers and acquisitions, preparing feasibility reports, market or industry studies for companies.
    • They are instrumental in addressing the financial needs of the country.

NBFCs Not Under RBI Regulations

RBI regulates only those NBFCs which deal in lending, accepting deposits, financial leasing, hire purchase and acquisition of shares/stocks, etc. Other NBFCs are being regulated by different regulators, depending on their business model. The companies engaged in activities like stock broking, merchant banking, etc. are regulated by SEBI in India. There are a few other regulators in India such as IRDA, National Housing Bank and Department of Company Affairs, etc.

NBFCs that are not being regulated by the RBI are exempt from the requirement of registration with RBI but they need to register with respective regulators.

For example:

    • Venture Capital Funding/Merchant banking Companies/Stock-broking Companies are registered with SEBI.
    • The Insurance Company needs to be registered with IRDA.
    • Housing Finance Companies are regulated by the National Housing Bank.
    • Nidhi Companies are notified u/s 620A of the Companies Act, 1956.
    • Chit Fund Companies as defined in clause (b) of Section 2 of the Chit Funds Act, 1982.
    • Non-Banking Non-Finance Companies come under the Companies Act, 1956.

Frequently Asked Questions

Q. What is an NBFC?

NBFC, also known as Non-Banking Financial Company, works under the Indian Companies Act. It provides loans and advances to the public. An NBFC company can acquire shares, stocks, bonds, debentures, and securities from the Government as well as the local authorities or some other marketable securities. It may be involved in hire-purchase, leasing, insurance business, chit fund business. But should not be involved in agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property. 

An NBFC Company accepts deposits, in lump sum or instalments, in different plans.

Q. What are is required for NBFC registration with RBI?

An institution willing to start business of non-banking financial activities as defined under Section 45 I (a) of the RBI Act, 1934 should comply with:

1.  It should be a company established u/s 3 of the Companies Act, 1956 or 2013,

2. It should have a minimum NOF of Rs. 200 lakh. (The minimum NOF required for specialized NBFCs like NBFC-MFIs, NBFC-Factors, and CICs is different).

Q. What are the types of NBFCs?

1.  Investment & Credit Company: A company with a principal business of Asset Finance- financing physical assets, Loan Companies- providing loans and advances for activities other than asset financing, and Investment Companies- acquisition of securities. These 3 earlier kinds of NBFCs were merged by RBI into this single category.

2. Infrastructure Finance Company (NBFC-IFC): IFCs are engaged in providing infrastructure loans, as their principal business. Minimum 75% of the total assets should be invested in such loans.

3. Infrastructure debt Fund (NBFC-IDF): IDFs facilitate the flow of long term finance into infrastructure projects. They raise resources by the issue of Rupee or Dollar denominated bonds of minimum 5-year maturity. Only IFCs can sponsor IDFs.

4. Mortgage Guarantee Company (NBFC-MGC): At least 90% of the business turnover is mortgage guarantee business or at least 90% of the gross income is from mortgage guarantee business. Their NOF must be minimum Rs. 100 crore.

5. Non-Operative Financial Holding Company (NOFHC): Through these companies, the entities/groups are allowed to set up a new bank, which will hold the bank and all other financial services companies regulated by RBI or other financial sector regulators. 

6. Micro-Finance Institutions (NBFC-MFI): The non-deposit taking financial institution with Minimum NOF of Rs.5 crore and above (for North-Eastern States of India, the limit is Rs. 2 crores). A wide range of services like savings, remittance, credit, insurance, also non-financial services like training, counselling, etc., are covered by MFIs.

7. Factors (NBFC-FACTORS): An NBFC-ND has the principal business of factoring. Its financial assets in the factoring business should make at least 50% of its total assets and its income derived from factoring business should be at least 50% of its gross income.

8. Systematically Important Core Investment Company (NBFC-CIC-ND-SI): Financial institutions involved in the business of acquisition of securities and shares. Holding minimum 90% of its total assets in the form of investment in shares and equity. 60% of the total assets shall be compulsorily convertible into equity shares within a period not exceeding 10 years from the date of issue. It can accept public funds but not trade in its investments in shares, debt or loans in group companies except through block sale for the purpose of dilution or disinvestment. The asset size must be Rs. 100 crore minimum.

Q. What is the difference between NBFCs & banks?

NBFCs provide loans and make investments. In this aspect their activities are the same as that of banks. However, there are some differences:

i. NBFCs cannot accept demand deposits,

ii. They do not form part of the payment and settlement system and cannot issue cheques drawn on itself,

iii. The deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs.

Q. What is the process of NBFC registration?

Apply online at the RBI official portal for the NBFC license. There is a set format prescribed by it. The application should be enclosed by the required documents supporting the application. After submission, a reference number gets generated.

1.  Submit the hard copies of the application and the documents, as uploaded online to the Regional Office of RBI.

2. After approving the submitted application, the regional office sends the application to the Central office of RBI. 

3. They go through a thorough examination. If all the terms under section 45-I A of RBI Act, 1934 are complied with then the NBFC certificate will be granted.

Q. What documents are required to apply for an NBFC license?

1.  Documents of the administration of the company.

2. Certificate of Incorporation of the Company.

3. MoA and AoA.

4. Address proof of the company.

5. Detailed information about Directors or Partners of the Company.

6. Well-audited accounts of the company for at least the last 3-consecutive years.

7. Board Resolution approving the formation of NBFC.

8. Bank Account having the paid-up equity share capital of minimum Rs. 2 Crore.

9. Latest KYC.

10. Net worth certificate.

11. Clean banker’s report.

12. Other relevant documents on request.

Q. What is meant by “principal business” for NBFC?

Principal business is when a company’s financial assets constitute more than 50% of the total assets and income from financial assets constitute more than 50% of the gross income. A company fulfilling both these conditions will be registered as NBFC by RBI. This test is popularly known as a 50-50 test.

Q. Does RBI regulate all financial companies?

No. Merchant Banking Companies, Housing Finance Companies, Stock Exchanges, Venture Capital Fund Companies, Nidhi Companies, Stock-broking/Sub-broking Companies, Insurance Companies, and Chit Fund Companies are NBFCs but they do not need to be registered with the RBI Act, 1934 subject to certain conditions. But are regulated by other regulators.

Q. What are the powers of RBI on NBFCs?

RBI can register, lay down policy, issue directions, regulate, supervise, inspect, and exercise surveillance over NBFCs that meet the 50-50 criteria of principal business. It can penalize NBFCs for violating the provisions of the RBI Act or the directions or orders issued under it. The penal action can also result in the cancelation of the Certificate of Registration issued, or prohibiting them from accepting deposits and alienating their assets or filing a winding-up petition.

Q. What action is taken if financial institutions do not register with RBI?

If financial companies whose principal business is lending, investment or accepting deposits, that must be registered with RBI as NBFCs, are found to not have a registration, RBI can impose penalty or fine on them. They can even be prosecuted in a court of law. Members of the public are invited to report such firms to the nearest Regional Office of the Reserve Bank. And appropriate action to be taken for violation of the provisions of the RBI Act, 1934.

Q. What are the regulations applicable to ND-NBFCs with asset size of less than Rs. 500 crore?

The provisions are as under:

a) They shall not be subject to any statutes, either prudential or conduct of business regulations. These are Fair Practices Code, KYC, etc., if they have not accessed any public funds and do not have a customer interface.

b) Those with a customer interface are subject to only conduct of business regulations including FPC, KYC, etc., if they are not accessing public funds.

c) If public funds are accepted, NBFCs will be subjected to limited prudential regulations but not conduct of business regulations if they do not have a customer interface.

d) When both public funds are accepted and the customer interface is there, those companies are subject to both the limited prudential regulations and the conduct of business regulations.​ubject to both the limited prudential regulations and the conduct of business regulations.

Q. What does the term public funds mean? Is it the same as public deposits?

Public funds include public deposits, bank finance, inter-corporate deposits, and all funds received whether directly or indirectly from outside sources. It could be funds raised by the issue of Commercial Papers etc.

Q. What is meant by NOF for NBFC?

First, let’s understand the meaning of “Owned Funds”. It means the aggregate of the paid-up equity capital, preference shares which are compulsorily convertible into equity, free reserves, and balance in share premium account and capital reserves representing surplus arising out of sale proceeds of assets. Exclude reserves created by revaluation of assets. Now, deduct the accumulated balance of loss, deferred revenue expenditure, and other intangible assets. NOF or “Net Owned Fund” is determined after deducting from the above amount, the amount of investments of such company in shares of its subsidiaries, companies in the same group and all other NBFCs. And the book value of bonds, debentures, outstanding loans or advances including hire purchase and lease finance made to and deposits with subsidiaries and companies in the same group. To the extent it is more than 10% of the owned fund.

Q. What compliances are required by the NBFCs?

I. Returns to be submitted by NBFC-Deposit Accepting are:

1. NBS-1 Quarterly returns on deposits in First Schedule.

2. NBS-2 Quarterly returns on Prudential Norms.

3. NBS-3 Quarterly returns on Liquid Assets.

4. NBS-4 Annual returns of critical parameters by a rejected company holding public deposits. 

5. NBS-6 Monthly returns on exposure to capital market institutions with total assets of Rs. 100 crore and above.

6. Half-yearly ALM returns with companies having public deposits of over Rs. 20 crore or asset size of over Rs. 100 crore

7. Audited Balance sheet and Auditor’s Report.

8. Branch Info Returns.

II. Returns to be submitted by NBFCs-ND-SI

1. NBS-7 Quarterly statement of capital funds, risk-weighted assets, risk asset ratio etc.

2. Monthly Returns on Important Financial Parameters.

3. ALM returns:

a) Monthly statement of short term dynamic liquidity in format ALM [NBS-ALM1],

b) Half-yearly statement of structural liquidity in format ALM [NBS-ALM2],

c) Half-yearly statement of Interest Rate Sensitivity in format ALM -[NBS-ALM3].

4. Branch Info returns.

5. Quarterly returns on important financial values & basic information like name of the company, address, NOF, profit/loss during the last 3-years of NBFC-NDs with assets between Rs. 50 crore and Rs. 100 crore.​ith assets between Rs. 50 crore and Rs. 100 crore.

Q. What is RNBC in NBFC?

RNBD or Residuary Non-Banking Company is a class of NBFC which is a company and has the principal business of receiving of deposits, under any scheme or arrangement or some other manner and not being Investment, Asset Financing or Loan Company. They are required to maintain investments and liquid assets as per the regulations of RBI. Their functioning is different from those of NBFCs in terms of method of mobilization of deposits and requirement of deployment of depositor’s funds as per Directions. Besides, Prudential Norms Directions apply to them also.

Q. Can all NBFCs accept deposits?

All NBFCs are not allowed to accept public deposits. Only the NBFCs which have taken a specific permission from RBI are allowed to accept/hold public deposits. They must have an investment-grade rating to a limit of 1.5 times of its NOF.

Q. What is the maximum interest an NBFC can pay on deposits?

The maximum annual rate of interest an NBFC can offer is 12.5%. The interest may be paid or compounded at rests of one month or over.

Q. NBFC can accept a deposit for how much duration?

NBFCs can accept/renew public deposits for a minimum period of 12 months and a maximum of 60 months. They cannot accept demand deposits.