What are Non-Banking Financial Companies?

Non-banking financial companies are not banks. They offer a range of services that are not traditionally offered by banks. These include loans, insurance, credit cards, mortgages and other financial products.

What are Non-Banking Financial Companies?

Non-Banking Financial Companies (NBFC) is a financial institution that does not have a banking license but provides various banking services. NBFC’s are not governed by a national or international banking regulatory agency. Investment Banks, Insurance Companies, Private Equity Funds, Hedge Funds, Mortgage Lenders, P2P Lenders, and Money Market Funds are all examples of NBFC’s. These institutes play a vital role in meeting the credit demand unmet by traditional banks. 

Non-Banking Financial Companies facilitate bank-related financial services, like contractual savings, investment, risk pooling, and market brokering. NBFCs play a pivotal role in strengthening the economy by providing multiple opportunities to transform savings into capital investments. 

Role of NBFCs in the Financial System

Non-Banking Financial Companies complement the banking system by providing infrastructure to distribute surplus resources to companies and individuals with deficits. While banks have a packaged deal of set financial services, the NBFCs tailor these services as per client needs. One of the most important things that differentiate NBFCs from banks is that they do not provide services for daily transactions like a savings account or a current account. In fact, it only takes time deposits or fixed deposits.

NBFCs offer a majority of the banking services, like credit facilities, loans, private education funds, money market trading, underwriting facilities, and retirement planning. These institutions also provide wealth management facilities, such as advice on mergers and acquisitions and managing stock portfolios. As the Venture Capital companies, and Retail and Industrial companies, entered the lending market business, the number of NBFCs sprouted in huge numbers. 

Non-Banking Financial Companies provide growth and stability to the economy. NBFCs are market-based financial systems, hence have a higher probability of growth than a bank-based system. Financial development and economic growth have a high correlation, meaning the more developed the financial system is, the stronger the economy gets. NBFCs protect the economy from financial shocks and encourage speedy recovery when it happens.

NBFCs encourage the strengthening of financial markets since the financial market heavily depends on these companies to raise capital. Non Banking Financial Companies also facilitate mobilizing funds. They help convert savings into investments, encouraging asset distribution, rotation of resources, and income regulation for better economic development. Since the NBFCs focus on building the capital market, which directly adds to the National income and thus results in an increase of Gross Domestic Product (GDP).

Since NBFCs are not regulated by the government or credit reporting agencies, their activities are highly unsupervised. The NBFCs can easily destabilize the financial system, holding a large share of the total financial assets. The 1997 Asian Financial crisis is one such example. Due to a lack of regulation on the NBFCs, a credit bubble was created, leading to inflation. When the asset price collapsed, and the loan default soared, it led to a credit crunch and rise in private debt, causing the financial crisis.

Different types of NBFCs

1. Investment Company 

An Investment Company is a financial institution whose principal business is the acquisition of securities. They provide finance by advancing loans and professional investment portfolio diversification and management.

2. Asset Finance Company (AFC)

Asset Finance Company is a financial institution that finances physical assets as their prime business. These financing activities promote productive-economic activity, like tractors, generators, earthmoving and material handling equipment, and general purpose industrial machinery.

3. Infrastructure Finance Company

The Infrastructure Finance company is an institution that utilizes more than 75% of its assets in providing infrastructure loans. These companies require assets worth 300 crores as the minimum valuation, and a minimum credit rating of ‘A.’ IFCs need a Capital Adequacy Ratio (CAR) of 15%.

4. Loan Company

A Loan Company under NBFC is any company with its principal business of providing finance by advancing loans. They offer loans as per the clients’ needs, such as demand loans, home loans, secured loans, unsecured loans, personal loans, commercial loans, and many others. Loan Companies are mostly small partnership entities that accept public deposits, provide a higher interest rate, and then advance loans to small businesses, with proprietors charging a high-interest rate. 

Risks Associated with NBFCs

If you are a depositor looking forward to depositing some money in an NBFC, there are certain precautions that one must take. Only the NBFCs registered with the Reserve Bank of India (RBI) are authorized to accept deposits. A list of these NBFCs is provided on RBIs website (www.rbi.org.in), and depositors must ensure the company in which they are depositing their money is not prohibited from performing the same. The NBFC must prominently display its Certificate of Registration (COR). 

The depositor must know the maximum interest rate that an NBFC can provide against their deposits. The maximum interest rate is usually 12.5%; any alteration or changes by the RBI are mentioned on the website. NBFC must give a receipt against the deposit, stating the name, date, amount (in words and figures), interest rate, maturity date, and must be duly signed by the designated officer. 

The Deposit Insurance facility is not available for the deposits made with Non-Banking Financial Companies. Hence, the depositor must be aware that it is an unsecured deposit, and the Reserve Bank of India does not take guarantee or responsibility for the financial soundness and situation of the company.

Also, check this article to know the importance of business finance.