A Non Banking Financial Institution or Non Banking financial company is a financial Institution that does not have a full banking license and not regulated as stringent as Banks are. They provide banking and financial services like loans, credit facilities, retirement planning, investing and stocking in money market. Example – Muthoot Finance, LIC Housing Finance, Bajaj finance etc. NBFCs play a very important role in Indian economy. NBFCs are also known as ‘Shadow Bank’.
Difference between NBFC and Bank
|ACT||·Indian Companies Act, 1956.||· Banking Regulation Act, 1949|
|Deposits Acceptance||Demand deposits – NO
Fixed/Time deposits -> Yes, but not all
|All type of Deposits|
|ATM Cards||Cannot issue||Can Issue|
|Insurance Policy||Can offer.||Banks are not allowed to offer insurance schemes directly.
Banks can collaborate with other insurers to offer insurance schemes.
|Payment and settlement cycle||Are not integral part of payment and settlement cycle.
So cannot issue cheques drawn on themselves
|Are an integral part
So, can issue cheques drawn on themselves
|CRR/SLR etc.||Not mandatory||Mandatory.|
|Deposit insured under Deposit Insurance and Credit Guarantee Corporation (DICGC).||No.||Yes.|
|FDI||In some type of NBFC 100 % FDI is allowed||PSU banks – 20%
private sector banks – 74% (Automatic -49%)
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Types of NBFCs
On the basis of Deposits
- (NBFCs-D) – NBFCs accepting public deposits.
- (NBFCs-ND) – NBFCs not accepting public deposits are engaged in loan, investment, hire purchase finance and equipment leasing activities.
- NBFCs not accepting public deposits and has acquired shares in their own group/subsidiary companies of not less than 90 percent of their total assets and are not trading in these shares.
On the basis of the nature of Activity
- Asset Finance Company (AFC) – To finance the assets such as machines, automobiles, generators, material equipments etc.
- Investment Company (IC) – Deals in securities.
- Loan Companies (LC) – To provide loans and advances (not for assets but for other purposes such as working capital finance etc.).
- Infrastructure Finance Company (IFC) – A company having net owned funds of at least Rs. 300 Crore and has provided 75 percent of its total assets in Infrastructure loans is called Infrastructure Finance Company provided it has credit rating of A or above and has a CRAR* of 15%.
- Systemically Important Core Investment Company (CIC-ND-SI) – A systematically important NBFC has assets above Rs. 100 crore which has provided at least 90% of its assets in the form of investment in shares or debt instruments or loans is called CIC-ND-SI.
- Infrastructure Debt Fund (IDF-NBFC) – A debt fund means an investment pool in which core holdings are fixed income investments
- Non-Banking Financial Company – Micro Finance Institution (NBFC-MFI) – is a non-deposit taking NBFC which has at least 85% of its assets in the form of microfinance.
- Non-Banking Financial Company – Factors (NBFC Factors) – It should have a minimum Net Owned Fund (NOF) of Rs. 5 Crore and its financial assets in the factoring business should constitute at least 75 percent of its total assets and its income derived from factoring business should not be less than 75 percent of its gross income. Factoring is the business of selling invoices (or receivables) to a third party called as “factor” at a discount.
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* Capital Adequacy Ratio
The Capital Adequacy Ratio (CAR) is the ratio of a bank’s capital to its risk. The Capital Adequacy Ratio is also known as capital-to-risk weighted assets ratio (CRAR). CRAR is used to protect depositors and promote the stability of financial institution around the world.
Sources of funds of NBFCs
- Borrowing from other financial institutions like banks.
- Raising money from public through term deposits or by issuing commercial Papers, Certificate of Deposits, Bonds etc.
Regulation of NBFCs
- RBI regulates the companies which deal in lending, accepting term deposits, acquisition of shares etc.
- NBFCs that deal with activities like stock broking, merchant banking etc. are regulated by SEBI
- Department of Company Affairs regulates companies like Nidhi and Chitfund.
- National Housing Bank regulates housing finance companies.
Role of NBFC
- Financing economically weaker section
- Supplementary role to the banks.
- Exclusively lending to the infrastructure sector and provide long term credit
- Attracting foreign grants. Some NBFCs cater to specific sectors like renewable energy and thus attract foreign grants in these sectors.
- Mobilization of funds for startups and MSMEs.
- NBFCs also diversify the financial sector, reducing the overall risk in the economy. If not NBFCs then money will get concentrated in few giant banks.
Issues plaguing NBFCs
Economy & Business Issue
- Cut throat competition from other banks. Banks are also coming up with innovative financial solutions thus giving tough competition to NBFCs
- Non Performing assets (NPA) and slow Industrial growth. Both NBFCs and banks are suffering from NPA crises.
See also: RBI framework on NPA resolution
Weak Regulation and Corporate governance
- Weak Capital Structure – Since NBFC is not a bank under RBI Act. The monetary policies like CAR, CRR, SLR etc are not applicable to them and hence they lend beyond their limits which ultimately creates a weak capital structure. Most of the NBFCs work on very thin equity capital base.
- Management Issues – NBFCs are facing management which lacks transparency and accountability.
- There is a tussle between Reserve Bank of India (RBI) and the Government regarding opening a special window to provide funding to NBFCs as the RBI is concerned of moral hazard and other sectors demanding the same.
- Failure of rating agencies – there is a conflict of interest as rating agencies are paid by the issuers whose securities they rate. Recently rating agencies did not monitor liquidity shortage at IL&FS and gave it AAA ratings; this was downgraded to junk after the crises unfolded.
- After the IL&FS crisis SEBI on 13th November 2018 issued a new circular where credit rating agencies (CRA) will now have to disclose the liquidity position of the companies they rate.
- New Accounting policies – The new Indian Accounting Standards (Ind-AS) is applicable to NBFCs from April 1, 2018. Loan-loss provisioning will now have to be made on expected credit loss (ECL) model, based on past trends and judgments of individual entities. However in long term this shift will result in stronger NBFCs, presently, it could see the net worth of many companies fall by as much as 10%.
- The sector is facing a liquidity crunch – NBFCs mostly generate liquidity through market borrowing and bank borrowing. At present due to mounting amount of NPA, banks are hesitating to lend anymore to NBFCs and market borrowing through bond or commercial paper is facing big difficulties.
- Banks have also restricted lending to the NBFCs as their ratings have turned poor. This has added to the crunch and reduced profits margins.
- NBFCs have started selling their stocks due to loss of leveraged positions. This has set off sales in other stocks as well, thus starting a vicious cycle.
There is an urgent need to stem the issues and crises being faced by the NBFC sector. Some external funding is essential to provide liquidity. In the long run, better institutional regulations and monitoring must be in place to prevent such asset – liability mismatches.
See also: Case study on IL&FS – NBFC crisis