In simple terms, Non-Banking Financial Companies are financial institutions that do not possess a banking license from the RBI but still provide bank-like financial services like loans, credit facilities, retirement planning, etc.

The need for an NBFC arises when the banking structure already present does not fulfill all the financial needs of the economy. These may be due to rules and regulations that bind the banking sector or lack of reach in the service provided and accessibility to certain consumers across the nation. Here are some examples of NBFCs:

Investment Banks, Mortgage Lenders, Money Market Funds, Insurance companies, Hedge and Private Equity Funds, Chit Funds

What is the significance of NBFCs?

• These organizations play a crucial role in the economy, offering their services in urban as well as rural areas, mostly granting loans allowing for the growth of new ventures.
• They alone count for 12.5% raise in the Gross Domestic Product of our country.
• Most people prefer NBFCs over banks as they find them safe, efficient, and quick in assisting with financial requirements.
• Moreover, there are various loan products available and there is flexibility and transparency in their services.

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956/2013 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 company incorporated under the Companies Act, 1956 and desirous of commencing the business of a non-banking financial institution as defined under Section 45 I(a) of the RBI Act, 1934 should comply with the following:

• It should be a company registered under Section 3 of the Companies Act, 1956;
• It should have a minimum net-owned fund of Rs.200 lakh.

Section 45 I(f) of the Reserve Bank of India (Amendment) Act, 1997 defines a non-banking financial company as:

• A financial institution which is a company;
• A non-banking institution which is a company with the principal business of receiving deposits, under any scheme or arrangement or in any other manner, or lending in any manner;
• Such other non-banking institutions or class of such institutions, as the Reserve Bank with the previous approval of the Central Government may specify by notification in the Official Gazette.

Residuary non-banking company

A non-banking institution that is a company and has its principal business of receiving deposits under any scheme or arrangement in one lump sum or in installments by way of contributions or any other manner, or lending in any manner is also a non-banking financial company.

Difference between NBFC and Bank

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 itself;
3. deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.
4. 100% foreign equity against 74% in banks

Government Policy

In May 1992, RBI constituted a working group under the chairmanship of Dr. A.C. Shah to conduct a comprehensive study of finance companies and recommend measures to facilitate their healthy growth. In its report submitted in September 1992, the group recommended specific regulations for companies and prescribed entry norms for new financial companies. It also prescribed capital adequacy standards, prudential norms for income recognition, and provisions for bad and doubtful debts.

The failure of Rs 1200 crore CRB Capital (a non-Government company incorporated in 1985) in May 1997 again focussed on the need to regulate the working of NBFCs.

The Government of India enacted the Reserve Bank of India (Amendment) Act, 1997 which confers wide-ranging powers on RBI for controlling the functioning of non-banking financial companies.

The act defines a non-banking financial company (NBFCs) as a financial institution that is a company and which has, as its principal business, the receiving of deposits under any scheme or arrangement and lending in any manner. Institutions carrying on the agricultural or industrial activity as their principal business are excluded from the definition of NBFC.

Salient Features of RBI Amendment Act, 1997

As per the Act, no NBFC can commence or carry on business;

• without obtaining from RBI a certificate of registration; and
• having net owned funds of Rs 50 lakhs or such other amount, not exceeding Rs 2 crores.

The existing NBFCs that fulfill the above financial requirements must apply for registration to the RBI within six months. The RBI is now entrusted with the numerous powers required to control the NBFCs.

To avoid systemic risks and for safeguarding the interest of depositors, in its mid-term review of the annual policy statement for 2004-05, the RBI proposed certain measures to improve the functioning of NBFCs.

These measures include

• transparency of operations, especially in the connected lending relationships,
• corporate governance standards including the professionalization of the Boards and ensuring ‘fit and proper criteria in consonance with the standards in banks,
• avoiding untenable rates of commission to agents
• adherence to ‘know your customer’ rules and
• customer service in terms of clear indication of the identifiable contact with the field agents so that matters such as unclaimed deposits are appropriately addressed.

Legislative control of NBFCs

• NBFCs do not have any specific legislation governing them
• Being limited liability companies, they are governed by the Companies Act, 1956 which does not even contain the definition of a finance company. Application of general provisions of this Act, perforce, has invited avoidable violations by NBFCs.
• In the matter of deposits, NBFCs are governed by Non-banking Financial Companies (Reserve Bank) Directions, 1997.
• Those engaged in merchant banking and portfolio management services are governed by SEBI.

Benefits of NBFCs

• They are increasingly being recognized as complementary to the banking system
• Play a crucial role in broadening access to financial services,
• enhancing competition and diversification of the financial sector.
• Capable of absorbing shocks and spreading risks at times of financial distress.
• Simplified sanction procedures,
• orientation toward customers,
• attractive rates of return on deposits and
• flexibility and timeliness in meeting the credit needs of specified sectors

RBI Customer Guidelines for NBFCs

The Reserve bank of India in 2004 issued “know your customer (KYC)” guidelines for non-banking financial companies (NBFCs), similar to those existing for commercial banks.

The ‘Know Your Customer’ framework is meant to work with two objectives –

1. to ensure customer identification and verify his identity and residential address and
2. to monitor transactions of a suspicious nature.

The guidelines will be applicable to all NBFCs, including Miscellaneous Non-Banking Companies (chit fund companies) and Residuary Non-Banking Companies.

Govt is considering enhancing RBI powers

• to improve its regulatory and supervisory mechanism for Non-Banking Financial Companies (NBFCs).
• Recent defaults and delays in loan repayments by a section of NBFCs have shaken the confidence in the financial markets, leading to fears that potential solvency risks at certain companies can be contagious.
• Need of the hour is to have an optimal level of regulation and supervision so that the NBFC sector is financially resilient and robust.
• More powers will enable RBI to close regulatory gaps between banks (which are tightly regulated) and NBFCs. The RBI has already reduced the periodicity of the NBFC supervision to 12 months from 18 months earlier.
• NBFCs were the largest net borrowers of funds from the financial system with gross payables of around Rs 8.44 lakh crore and gross receivables of around Rs 7.23 lakh crore as of end-March 2019.
• These companies depend largely on public funds such as bank borrowings, debentures, and commercial papers, which account for 70 percent of the total liabilities of the sector.
• When banks and mutual funds stop fresh loans to NBFCs facing default possibility, it can potentially lead to contagion in the financial markets.
• There are more than 10,000 NBFCs in the country and they play a vital role in the economy as the third and most engaged layer of the financial system.
• NBFCs defined as “large”, with assets of more than Rs 5 billion being considered systemically important and have been subject to differing requirements.
• Unlike banks, Non-Banking Financial Companies (NBFC) do not have access to low-cost public deposits and have to heavily rely upon commercial paper and commercial debt markets.

Ombudsman Scheme for Non-Banking Financial Companies NBFCs

• The RBI has separate ombudsman systems for non-banking financial companies and digital transactions. The banking ombudsman has been in place since 2006, while the one for NBFCs came in 2018 and the one for digital transactions came in as early as 2019.
• The NBFC ombudsman was first announced for deposit-taking NBFCs. It has been recently extended to other NBFCs as well. However, this scheme is applicable to NBFCs having an asset size of Rs 100 crore and above.
• At present, it has four offices— at Chennai, Mumbai, New Delhi and Kolkata. The complaints can be filed offline or through an e-mail.
• Similar to the banking ombudsman, you first need to approach the NBFC for your dispute resolution.

Different types of NBFCs