NBFC

Non-Banking Financial Institutions: What They Are and How They Work?

Non-Banking Financial Institutions

A Non-Banking Financial Company or Non-Banking Financial Institutions are an organization that is incorporated under the Companies Act of 1956 and 2013. By introducing diversity and efficiency into the financial industry, these enterprises have significantly contributed to India’s financial system. The operations, asset quality, heterogeneity, profitability, and regulatory architecture of NBFCs have evolved over the years. Moreover, by serving as backup institutions when banks are under pressure, they strengthen the financial system’s resilience in the nation. 

NBFC Definition

According to the Companies Act of 2013, a non-banking financial company or NBFC is a kind of business involved in receiving loans and credit facilities, buying bonds, stocks, or shares, hiring and purchasing, leasing, insurance, financial assets, exchanging currencies, peer-peer lending, hedge funds, chit business, etc. Under the Companies Act, NBFC registration is carried out. And Section 45-IA of the RBI Act, 1934’s requirements further control them.

However, businesses involved in agriculture, Industrial business, the purchase or sale of any goods and services (excluding securities), and the sale, purchase, or construction of immovable property are not NBFCs. 

How do NBFCs differ from Banks?

Though similar actions are carried out by banks and NBFCs, there are several notable distinctions between them.

  • NBFCs provide people with banking-like services without holding a bank license.
  • Demand deposits are not allowed to be accepted by NBFCs.
  • The DICGC does not offer deposit insurance to NBFC depositors as it does to bank depositors.
  • Under the automatic route, 100% FDI is allowed in NBFCs in certain activities with minimum capitalization requirements.
  • These organizations are not part of India’s payment and settlement system. As a result, they would be unable to issue checks drawn on themselves.

NBFC Incorporation

 The below-mentioned steps should be taken in order to incorporate a non-banking financial company.

  • First, make sure the business is registered under the Companies Act of 1956 or 2013.
  • A minimum of one full-time director with experience working for an NBFC or a senior banker is required to be the director of the organisation.
  • The net owned funds of the company should be at least 2 crores.
  • It is crucial that the CIBIL records of the company are acceptable.
  • Once the aforementioned requirements have been met, an online application for the establishment of the NBFC should be submitted on the RBI’s official website. The application should be submitted with the necessary supporting documents.
  • A pertinent CARN number would be generated.
  • The application should be sent to the regional branch of the RBI with a hard copy.
  • After the application has been evaluated and thoroughly examined, the NBFC license will be issued to the particular company.
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Types of Non-Banking Financial Institutions

Generally, NBFCs fall into one of these two major categories:

A). On the basis of Liabilities

1. Deposits Accepting NBFCs

2. Non-Deposit Accepting NBFCs

Non-Deposit talking NBFCs are further categorised by their size as

1. Systematically Important (NBFC-NDSI), and 

2. Non-Deposit holding companies (NBFC-ND).

B). By the kind of activity which they conduct

The various Non-Banking Financial Company types that exist in India, together with the activities they carry out, are listed below:

Asset Finance Company (AFC): A corporation that operates as a financial institution (FI) and focuses on financing the purchase of physical assets that support economic and productive activity, such as automobiles, tractors, lathe machines, generators sets, earthmoving and material handling equipment, moving on own power and general purpose industrial machines. The term ‘primary business’ refers to an organisation that finances real or tangible assets that support economic activity, and the income from those must account for at least 60% of the organization’s total assets and income, respectively.

Investment Company (IC): An organization engaged in financial service with the acquisition of securities as its primary business.

Loan Company (LC): A financial institution that conducts its primary business of providing finance through loans, advances, or some other method, for any activity other than its own, excluding asset finance companies.

Infrastructure Finance Company: This is a Non-Banking Financial Company with the following characteristics:                         

  • It invests at least 75% of its total assets in infrastructure loans. 
  • It has at least Rs.300 crore in net-owned funds.
  • It has a credit rating of at least 75% of its total assets or a comparable level.
  • It has a Capital to Risk-Weighted Assets Ratio of 15%.
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Systematic Important Core Investment Company: This NBFC engages in the business of acquiring securities and shares.

(a) It maintains at least 90% of its total assets in debt or loans to group companies, as well as investments in equity shares, preference shares, and other securities.

(b) At least 60% of its total assets are invested in equity shares of group firms, including instruments that are compulsorily convertible into equity shares within ten years of the date of issue.

(c) unless through a block sale for the purpose of diluting or disinvesting, it doesn’t trade in its investments in shares, loans or debts in group companies.

(d) Other than investing in bank deposits, money market instruments, government securities, loans to and investments in debt issuances of group companies, or guarantees issued on behalf of group companies, it does not engage in any other financial activity as defined in Sections 45I(c) and 45I(f) of the RBI Act, 1934[1].

(e) Its asset size is 100 crore or more.

(f) It accepts public funding.

Infrastructure Debt Fund (IDF): An organisation licensed as an NBFC that facilitates the flow of long-term debt into infrastructure projects is known as IDF-NBFC. It raises money by issuing bonds with a minimum 5-year maturity that are denominated in Rupees or dollars. IDF can be sponsored by Infrastructure Finance Companies. 

Micro Finance Institution (NBFC-MFI): An NBFC that does not accept deposits and has at least 85% of its assets in the following categories of “qualifying assets”:

  • Loan disbursed by an NBFC-MFI to a borrower in a rural household with an annual income of not more than Rs. 1,00,000 or in an urban or semi-urban household with an annual income of not more than Rs. 1,60,000;
  • The maximum loan amount in the first cycle is Rs. 50,000, and in the subsequent cycle is Rs. 1, 00,000.
  • In case of loan amount exceeds Rs. 15,000, the term of the loan cannot be less than 24 months, with early repayment without penalty.
  • Loan to be extended without any security.
  • The borrower’s total debt should not exceed Rs. 1,00,000
  • The aggregate amount of loans given for income generation, isn’t less than 50% of the total loans given by the MFIs,
  • The loan is repayable in weekly, fortnightly or monthly instalments as chosen by the borrower.
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Factors (NBFC-Factors): An NBFC with the primary activity of factoring is a Non-Deposit Accepting NBFC. At least half of the company’s total assets should be in the form of financial assets, and the income generated by the factoring business should not be less than half of its gross income.

Mortgage Guarantee Companies (MGCs): Financial institutions (FIs) whose mortgage guarantee business is not less than 90% of their business revenue or not less than 90% of their gross income and whose net owned funds total is Rs. 100 crores.

Non-Operative Financial Holding Companies (NBFC-NOFHC): These FIs allow promoters and promoter groups to establish new banks. It is a wholly-owned NOFHC that will hold the bank as well as all other financial services companies governed by the RBI or other financial sector regulators.

Role of NBFC in the Financial System

The Indian capital market has had tremendous ups and downs in the past two decades. The number of transactions on the capital markets has substantially increased. New financial institutions have emerged and have become crucial, such as merchant banks, mutual funds, and venture capital firms.

Further, NBFCs frequently take the initiative in offering MSMEs providing financial services that are best suited to their needs as a business. NBFCs work in addition to banks to offer people and businesses financial services. They are competing with banks in these services. Banks may offer a package of financial services, whereas (Non-Banking Financial Institutions) NBFIs unbundle these services and customise them for certain populations. Individual (Non-Banking Financial Institutions) NBFIs may also specialise in a specific industry to gain an informational advantage. The unbundling, targeting and specialization practices of (Non-Banking Financial Institutions) NBFIs promote competition in the financial service industry.

Having a complex financial system, including NBFC, can shield economies from financial shocks and help them recover from them. If the primary form of intermediation fails, NBFCs offer a variety of backup options for converting savings into capital investment.

Conclusion

The banking sector will always be of utmost importance in the world of business, the NBFC plays a crucial role, and its presence in a nation only serves to strengthen the economy. Because of improved technology and the desire for a deeper understanding, more companies are reaching NBFC. Given the benefits of using its service, working together with NBFC has proven to be an effective and reasonable commercial cooperation for organizations. 

Read our Article: What is a Non Banking Financial Company (NBFC)?

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