Understanding NBFC – Meaning, Types, and Role in Finance

Nonbank financial companies is the full form for NBFC which are entities that provide bank-like financial services but do not hold a banking licence and are not subject to the same regulations as traditional banks.

Understanding NBFCs

What is an NBFC and what does it offer? – NBFCs offer various financial services, such as loans, credit facilities, currency exchange, retirement planning, money market operations, underwriting, and merger activities. They are not allowed to accept traditional demand deposits like checking or savings accounts from the public. NBFCs fall under the oversight of the Dodd-Frank Act, which defines them as companies predominantly engaged in financial activities. Non-Banking Financial Companies (NBFCs) offer flexible business loans at Lendingkart tailored to the specific needs of entrepreneurs and small business owners.

Also Read: NBFC Registration – Types, Process, Fees, Documents

Role of NBFCs in India

Over the past decades, India has done remarkably well. Of all the sectors, the contribution made by the non banking financial companies sector has been nothing short of exceptional! The importance of non banking financial institutions is paramount, and there are various roles that NBFCs play, some of them are listed below:

• Bridging the credit Gap : One of the major roles played by NBFCs is that it has been instrumental in extending credit to the underserved areas and segments of the economy. These sectors have had a greater credit requirement that traditional banks have historically managed to fulfill.
• Financial market stability : Another important role that NBFCs have played is to help financial market stability. With being able to operate as dependable intermediaries and financial institutions, the NBFCs have been instrumental in strengthening the financial market stability over the last couple of years in India.
• Resources mobilization : The utmost goal of the financial market is to mobilize savings into investments, this helps in economic development of the country. The NBFCs have been a massive success in helping mobilize the resources from savers to investors, which has been instrumental in the economic transformation process. This role of non banking financial companies has been a major driver in economic growth of the country.

NBFC Controversy

NBFCs have proliferated since the Great Recession, playing a key role in meeting credit demand unmet by traditional banks. However, their lack of accountability to regulators and ability to operate outside the customary banking system have raised concerns. Critics argue that NBFCs’ non-transparent operations and systemic risk to the financial system and economy are troubling. NBFCs play a crucial role in providing working capital loans, helping businesses maintain liquidity and meet their short-term financial obligations. Also, MSMEs often turn to NBFCs for MSME loans, benefiting from simplified application processes and faster disbursal compared to traditional banks.

What Is the Difference Between NBFCs and NBFIs?

Why Are NBFCs Called Shadow Banks, and what is the primary difference between NBFC and Bank?

One of the major difference between NBFCs and Banks is that the banks are subjected to stricter regulations. Although NBFCs offer services which closely mirror those of banks’ offerings, the only major restriction being – NBFCs cannot accept deposits, unlike traditional banks. NBFCs are often less regulated, hence these are more commonly referred to as Shadow banks. Hence, although these companies have bank-like activities, these are not a part of the banking sector. Before the Dodd-Frank Act, NBFCs were referred to as “shadow banks” to describe the fast-expanding plethora of unregulated financial entities. NBFCs are significant contributors to the PMMY scheme, supporting micro-enterprises by offering accessible and affordable financing options.

Also Read: Which is better for Business Loan – Banks or NBFC?

Process of incorporation of a Non-Banking Financial Corporation (NBFC)

Here is the process of incorporation of a Non-Banking Financial Corporation (NBFC):

• Obtain an in-principle approval from the Reserve Bank of India (RBI) for setting up an NBFC. Since the Reserve Bank of India is the apex regulatory body for banks and financial institutions in the lending and borrowing space, it is essential to obtain an in-principal approval from the RBI to ensure that the company is not in breach of rules and regulation put forth by the RBI. This is essential to follow for all companies operating in the NBFC sector.
• Incorporate the company under the Companies Act, 2013. It is imperative to be registered with the companies register. As a company operating in India, the first step in being fully compliant is to get the company registered under the companies act, 2013. This ensures that the company follows corporate governance as deemed fit by the government.
• Apply for a Certificate of Registration (CoR) from the RBI. The certificate of registration is absolutely essential if you want to start operating an NBFC in India. This certificate of registration indicates that the business is in compliance with all the rules and regulation put forth by the RBI, and the RBI considers the business as fit to register and operate in the country as a non banking financial company
• Comply with the minimum net owned fund requirement of ₹2 crore. This is one of the primary requirements set by the authorities to ensure that the NBFC is not fully started on leverage and the entrepreneur is investing their own funds in starting the business.
• Appoint a CEO and other key managerial personnel. Companies act, 2013 ensures transparent corporate governance for companies operating in India. For a business in the NBFC space to run, one of the most important and essential things to do is to appoint key managerial positions, and delegate authority that comes with the position to ensure accountability within the organization and to give the company a clear and defined structure, and hierarchy.
• Establish the registered office and maintain books of accounts. For any company operating in a highly regulated space, it is essential to maintain books of accounts that reflect accurate financial position of the company. Furthermore, a registered office should be in place where the decision makers, and key managerial personnel are based and operate out of.
• Comply with the prudential norms prescribed by the RBI. Although NBFCs are called shadow banks, and are not allowed to accept deposits, the offering and function of NBFCs include a lot of products that are typically offered by banks. For companies operating in such highly regulated space, it is essential to be compliant with all the rules and regulations put forth by the regulatory body governing the industry (RBI in case of NBFCs). Failing to comply with these regulations may result in severe penalties and consequences.
• Obtain necessary approvals and licenses for the proposed activities. Depending upon the activities that are planned to be offered by the NBFC, certain approvals are needed to be taken from relevant authorities. These approvals will help in smooth operation of the company while avoiding the risk of severe consequences.
• Commence business operations after receiving the CoR from the RBI. The certificate of registration (COR) signifies that the NBFC is in compliance with rules and regulations put together by the RBI and the reserve bank is satisfied with the prerequisites. Having a CoR can help in obtaining further approvals from relevant authorities as it is an essential document to operate an NBFC in India.

What can be done in case a Non-Banking Financial Corporation (NBFC) defaults and fails to pay the amount taken?

If an NBFC defaults on payments, the aggrieved party can file a complaint with the RBI’s Integrated Ombudsman Scheme. The RBI may also initiate regulatory action against the NBFC, including cancellation of its certificate of registration. In extreme cases, the RBI may refer the NBFC to the National Company Law Tribunal (NCLT) for insolvency proceedings.

Frequently Asked Questions:

1. What is an example of a NBFC company?

An example of an NBFC company is LIC Housing Finance Limited, a non-banking financial company in India that provides housing finance services. It is a subsidiary of Life Insurance Corporation of India and has been a prominent player in the mortgage loan sector since its establishment in 1989.

2. Which is the no. 1 NBFC in India?

HDFC Ltd. is considered the number one NBFC in India. It is a leading non-banking financial company that specialises in housing finance and has a significant market presence in the country. HDFC Ltd. is renowned for its extensive range of financial products and services tailored to the housing sector.

3. Why is NBFC different from a bank?

NBFCs differ from banks primarily in their licensing and operational scope. While NBFCs provide banking services without holding a banking licence, they do not accept demand deposits from the public like traditional banks. This distinction allows NBFCs to offer specific banking services while operating outside the conventional banking system.