How are NBFCs different from Banks

Varun Hariharan

09 Feb, 2021

A lot of individuals would come across the word NBFC.  Hearing this, they would think that all finance companies established would carry out activities related to a Bank.  For example, a layman would not find many differences between a private sector bank such as Kotak Mahindra Bank Limited and Bajaj Finance. However, there are specific differences between a bank and an NBFC. This article describes How are NBFCs different from Banks.

What is an NBFC

An NBFC is an abbreviation for Non- Banking Financial Company, which is primarily formed for carrying out financing activities. This type of company is registered under the provisions of the Companies Act, 1956 for carrying out activities related to finance.

An NBFC carries out the following activities:

• Providing Loans and Advances
• Acquisition of Securities such as Shares and Debentures
• Leasing and Hire Purchase
• Chit Funds Business

However, such an institution that goes for NBFC registration in India cannot carry out any industrial activity allied to farming.

What is a Bank?

A bank is defined as an institution which is governed by the provisions of the Banking Regulation Act.

Apart from this, the activities carried out by a Bank would include the following:

• Providing of Loans and Advances
• Opening Accounts of Customers
• Providing Cheques
• Accepting Deposits
• Any other activity which is allowed and regulated by the Reserve Bank of India

From the above, it can be observed that the activities carried out by an NBFC do not include taking or accepting some form of deposits from the public. However, a bank which is established under the provisions of the RBI^[1] can accept any form of deposits from the public.

Differences between NBFC and Banks

• Accepting Deposits- Some NBFCs accept fixed deposits. A Bank even accepts these forms of deposits. However, it is important to classify the meaning of fixed deposits. In terms of rating, deposits of NBFCs are rated by reputed credit rating agencies such as CRISIL. However, when it comes to banks, such fixed deposits are not rated by reputed credit agencies such as CRISIL.
  
• Insurance on Fixed Deposit-Usually insurance is available for fixed deposits which are provided by Banks. However, the same would not apply to NBFCs. No form of insurance is present for fixed deposits of NBFCs. On default of more than a specific amount, the Deposit Insurance and Credit Guarantee Corporation of India would pay the bank as a guarantee. Such facilities are not available for an NBFC.
  
• Technology and AI- NBFCs are more aligned at using technologies and artificial intelligence in carrying out different forms of banking processes. Usually, NBFCs collaborate with Fin Tech Companies in India to carry out these objectives. These software and financial technologies allow entities to engage actively with the public for the provision of products.
  

Previously banks did not take the benefits of modern technologies and artificial intelligence software’s to promote their products. Automation software makes the work easier for finance. However, now the trends are changing, and banks are more aligned to utilize technology to enhance their products.

• Interest Rates- Usually the rate of interest offered by an NBFC is usually more than the amount of interest offered by a bank.
• Lending- When it comes to lending activities then both the above institutions carry out activities related to lending. NBFCs lend more towards the consumer and the retail sector. Usually some form of automobile finance, vehicle finance or consumer loans would be provided by an NBFC. Hence an individual considering the NBFC registration process must take into the effects due to lending. However banks usually lend for large construction and infrastructure projects. Any individual going for NBFC registration has to take the above criteria before forming a NBFC or a Bank.
• Provision of Credit Cards- When considering NBFC registration process, credit card facilities are not provided by a traditional NBFC. However, banks provide credit card facilities and other forms of electronic money which is available to consumers. Hence depending on the requirements of the individual, all the above differences have to be considered before going for NBFC registration.
• Strict Compliance-Both NBFCs and Banks are regulated by the RBI. However the compliance requirements for NBFCs are more when compared to banks. When an individual goes for NBFC registration, there are different forms of compliances required to be followed after the NBFC is registered. Plus there are lot of post compliance requirements for NBFC registration when compared to that of a bank.

Hence all the above differences have to be considered by an individual before going for the process of NBFC registration. These differences are crucial in identifying the strengths and weaknesses of these financial institutions.

Conclusion

Read our article:NBFC Registration Procedure with Reserve Bank of India