Non-Banking Financial Company

A Non-Banking Financial Company (NBFC) is a financial institution that provides banking and financial services similar to those offered by conventional banks but does not hold a banking licence and cannot accept demand deposits. NBFCs play a vital role in India’s financial system by extending credit to sectors and groups often underserved by traditional banks, such as small businesses, microenterprises, and individuals in rural or semi-urban areas.

Definition and Legal Framework

According to the Reserve Bank of India (RBI) Act, 1934, a Non-Banking Financial Company is defined as a company:

“engaged in the business of loans and advances, acquisition of shares, stock, bonds, debentures, securities issued by the government or local authority, or other marketable securities, leasing, hire-purchase, insurance business, or chit fund business, but does not include any institution whose principal business is that of agriculture, industrial activity, purchase or sale of goods, or providing services.”

NBFCs are registered under the Companies Act, 2013 (previously under the Companies Act, 1956) and are regulated by the Reserve Bank of India. They must obtain a Certificate of Registration (CoR) from the RBI to commence operations.

Distinction Between NBFCs and Banks

While NBFCs perform functions similar to banks, there are several key differences:

Despite these differences, NBFCs serve as important financial intermediaries, complementing the role of banks in the economy.

Classification of NBFCs

The Reserve Bank of India classifies NBFCs based on their activities and liabilities structure.
1. Based on Activities:

• NBFC-Investment and Credit Company (NBFC-ICC): Engaged in lending, acquisition of shares, bonds, debentures, or other securities.
• NBFC-Micro Finance Institution (NBFC-MFI): Provides microloans to low-income individuals or groups, especially in rural areas.
• NBFC-Factor: Engaged in factoring business, i.e., financing against receivables.
• NBFC-Infrastructure Finance Company (NBFC-IFC): Provides long-term finance to infrastructure projects.
• NBFC-Infrastructure Debt Fund (NBFC-IDF): Focuses on refinancing infrastructure projects.
• NBFC-Mortgage Guarantee Company: Provides mortgage guarantees for housing loans.
• NBFC-Housing Finance Company (HFC): Specialises in lending for housing and construction.
• NBFC-Account Aggregator: Facilitates sharing of financial information between institutions with customer consent.
• NBFC-Peer-to-Peer Lending Platform (NBFC-P2P): Operates digital platforms connecting lenders and borrowers.
• NBFC-Core Investment Company (CIC): Holds investments in group companies without trading or lending to others.

2. Based on Liabilities:

• Deposit-taking NBFCs (NBFC-D): Authorised to accept limited public deposits under RBI regulations.
• Non-deposit-taking NBFCs (NBFC-ND): Cannot accept public deposits but may raise funds from other sources.

Within NBFC-NDs, there is a further subclassification:

• Systemically Important NBFCs (NBFC-ND-SI): Those with asset size of ₹500 crore or more, regulated more strictly due to their potential impact on financial stability.

Functions of NBFCs

NBFCs perform a wide range of financial functions that contribute to economic development:

• Credit Provision: Providing loans for personal, commercial, and industrial purposes.
• Infrastructure Financing: Funding large-scale infrastructure projects such as roads, ports, and power plants.
• Asset Financing: Offering leasing and hire-purchase facilities for vehicles, machinery, and equipment.
• Microfinance Services: Extending small loans to self-employed individuals and low-income households.
• Wealth and Investment Services: Offering mutual funds, insurance, and portfolio management services.
• Financial Inclusion: Bringing credit access to unbanked and underbanked populations.

Regulatory Framework

The regulation of NBFCs is governed by the Reserve Bank of India (Amendment) Act, 1997 and related RBI directives. Key provisions include:

• NBFCs must obtain Certificate of Registration (CoR) from the RBI.
• They must maintain a minimum Net Owned Fund (NOF) of ₹10 crore (earlier ₹2 crore).
• They are required to adhere to Prudential Norms, including capital adequacy, asset classification, provisioning, and exposure limits.
• NBFCs are subject to periodic inspections, audits, and reporting requirements under RBI supervision.
• The Fair Practices Code (FPC) mandates transparency in lending, disclosure of interest rates, and grievance redressal mechanisms.

Role in the Indian Economy

NBFCs play an indispensable role in supplementing the banking system and driving inclusive economic growth. Their contributions include:

• Financing Underserved Sectors: NBFCs cater to sectors such as small-scale industries, agriculture, retail, and services, often overlooked by commercial banks.
• Employment Generation: By funding small and medium enterprises (SMEs), NBFCs promote entrepreneurship and job creation.
• Financial Innovation: Introduction of digital lending, fintech partnerships, and customised loan products has enhanced accessibility.
• Infrastructure Development: NBFCs are major financiers of power, transport, and telecommunication projects.
• Rural Development: Through microfinance and agricultural loans, NBFCs promote rural prosperity and financial inclusion.

Advantages of NBFCs

• Flexibility: NBFCs can design tailored financial products based on customer needs.
• Quick Loan Processing: Simplified procedures enable faster disbursement of credit.
• Wide Reach: NBFCs penetrate remote and rural markets where banking services are limited.
• Encouragement to Entrepreneurship: They provide funding to startups and small businesses.
• Diversification of Financial Services: NBFCs contribute to the expansion of the financial sector beyond traditional banking.

Challenges and Risks

Despite their growing significance, NBFCs face several challenges:

• Liquidity Risks: Heavy reliance on short-term borrowings may cause liquidity crises during market disruptions.
• Asset-Liability Mismatch: Mismatch between short-term liabilities and long-term assets can create financial instability.
• Regulatory Compliance: Increased RBI scrutiny and capital adequacy norms raise compliance costs.
• Credit Risk: Higher exposure to subprime borrowers increases chances of defaults.
• Systemic Vulnerability: Failures of large NBFCs, such as IL&FS in 2018, highlighted contagion risks within the financial system.

Recent Reforms and Developments

The RBI has introduced several regulatory measures to strengthen the NBFC sector:

• Scale-Based Regulation Framework (2021): A four-layered regulatory structure—Base, Middle, Upper, and Top Layers—based on size, activity, and risk exposure.
• Liquidity Coverage Ratio (LCR): Mandatory maintenance of high-quality liquid assets to meet short-term obligations.
• Enhanced Governance Norms: Strengthening of board oversight, disclosure, and risk management frameworks.
• Merger and Consolidation: Encouraging consolidation to create financially stronger entities.
• Digital NBFCs: Encouragement of fintech collaboration for online credit delivery and analytics-based lending.

Prominent NBFCs in India

Some major NBFCs operating in India include:

• Bajaj Finance Ltd.
• HDFC Ltd. (now merged with HDFC Bank)
• Mahindra & Mahindra Financial Services Ltd.
• Tata Capital Financial Services Ltd.
• Shriram Transport Finance Co. Ltd.
• Muthoot Finance Ltd.
• Manappuram Finance Ltd.

These companies operate across various financial segments, from retail lending to infrastructure financing.

Contribution to Financial Inclusion

NBFCs have significantly advanced India’s financial inclusion agenda by providing credit access to individuals and small enterprises excluded from the formal banking system. They have leveraged technology-driven models, doorstep services, and flexible repayment structures to reach rural and low-income populations, thereby complementing government initiatives like Pradhan Mantri Jan Dhan Yojana (PMJDY) and Digital India.