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NBFC : Full Form, Role, Objectives, Functions and Examples

Last Updated : 11 Dec, 2023
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What are NBFCs?

NBFCs are financial institutions that offer various financial services similar to traditional banks, but they operate without a banking license. Unlike banks, NBFCs cannot accept demand deposits, but they can provide loans and advances, asset financing, wealth management, and other financial products. A Non-Banking Financial Company (NBFC) is a company that is registered under the Companies Act, 1956 or the Companies Act, 2013 engaged in the business of advancing a loan, acquisition of stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of leasing, hire-purchase, insurance business, chit business. It does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities), or providing any services and sale/purchase/construction of immovable property.

Full Form of NBFC

NBFC stands for Non-Banking Financial Companies. NBFCs are financial institutions that offer various financial services similar to traditional banks, but they operate without a banking license. Unlike banks, NBFCs cannot accept demand deposits, but they can provide loans and advances, asset financing, wealth management, and other financial products.

Role of NBFCs

1. Providing Credit Needs: NBFCs play an important role in the Indian financial system, especially because their role is vital in providing credit to sectors that are not served by traditional banks. This helps the financial inclusion of the ignored sector.

2. Cater Requirements of Ignored Sectors: NBFCs are important as they cater to the needs of small businesses, low-income households, and other underserved markets, filling the gaps that are left by banks. NBFC helps to sort out the needs of unorganised sectors.

3. Fulfill Fund Requirements: NBFCs also play a significant role in the growth of the economy by providing fund requirements for investment and infrastructure projects.

4. Other Financial Products: The role of NBFCs in India is very vast and fast-growing, given the increasing demand for credit and financial services in developing nations like India. They offer a wide range of financial products and services that are boon for the public at large, such as Personal Loans, Business Loans, Vehicle Loans, Loan Against Property, and other credit facilities.

5. Manages Investments: NBFCs also provide investment opportunities to the public as they offer a wide range of mutual funds, fixed deposits, and other investment products, and they also provide investment advisory for investment-related schemes.

History of NBFCs

The concept of NBFCs came to India in the 1960s, it was seen as an alternative for individuals whose financial needs were not sufficiently met by the existing banking system due to less credibility or due to strict paperwork. In the early days of inception, Non-Banking Financial Companies were initially small organisations and did not make much impact on the financial industry at large. In December 1964, The Reserve Bank of India amended the RBI Act, of 1934, and new rules and regulations were established for NBFCs. This act helped NBFCs to get established in India. Later, the government of India established two committees to review the existing structure and working of NBFCs in India.

1. James S Raj Committee: This Committee was established in the 1970s to study the existing framework of NBFCs. The committee made a recommendation to establish uniform chit-fund legislation for the entire nation.

2. Chakravarty Committee: This Committee committee was established in 1982 to review the monetary system which was working in India. The committee made a recommendation for a complete evaluation of interlinking between the banking sector and NBFCs.

As of today, NBFCs have grown exponentially in terms of operations, range of instruments and market products, technological advancement, and customer base.

Objectives of NBFCs

1. Financial Inclusion: NBFCs’ main objective is to promote financial inclusion by extending credit and financial services to ignored sectors of the economy, as the primary banking sector relies on collaterals and stringent documentation which many unorganised sectors lack in.

2. Meeting Specific Needs: NBFCs help to cater the specific financial needs like consumer finance, microfinance, housing finance, vehicle finance, etc. This helps individuals to overcome the challenges of short-term requirements and maintain the standard of living in the growing modern era.

3. Investment Services: NBFCs also provide investment-related services like portfolio management, wealth management, securities trading, mutual funds, etc. to their customers. They also provide investment advisory to their customers allowing them to stay aware of the changing investment market and generate value by successfully investing in the most favorable investment schemes.

4. Asset Financing: NBFCs specialise in asset financing, by offering loans and credit facilities at the best rates for purchasing assets like vehicles, machinery, and equipment. This service of NBFCs not only help big businesses but also helps small businessman to set up their business and manage fund requirements for establishing capital assets which are crucial for the establishment of business and adds to nation-building.

Functions of NBFCs

1. Lending and Credit: NBFCs provide flexible lending solutions and credit facilities, which include personal, vehicle, housing financing, etc., to individuals and businesses.

2. Asset Financing: NBFCs are engaged in asset financing, which includes satisfaction of funds requirement for the purchase or leasing of capital assets such as machinery, equipment, vehicles, or real estate.

3. Investment and Advisory Services: NBFCs offer investment advisory, portfolio management, and risk assessment services in some cases. NBFCs also facilitate investments in securities, mutual funds, and other financial instruments to the public and businesses.

4. Leasing and Hire-Purchase: NBFCs also take part in leasing and hire-purchase activities, enabling individuals and businesses to acquire assets without full payment and subscribe to the asset on payment of periodic installments.

5. Factoring and Invoice Discounting: NBFCs provide factoring and invoice discounting services. This helps individuals and businesses with immediate liquidity, which helps them to overcome working capital needs.

6. Foreign Exchange Services: NBFCs also offer foreign exchange services, which include currency exchange and remittance transactions.

Types of NBFCs

1. Asset Finance Company: AFC is a financial institution that facilitates the service of financing the various assets for individuals and businesses which include machinery, heavy equipment, production and farming equipment, and large power generators which involves large capital expenditure. The income arising should not less be than 60% of their total assets. UTI AMC, ICICI AMC, and BIRLA SUN LIFE AMC are a few examples of asset finance companies.

2. Investment Company: These are the financial institutions whose principal business is the acquisition of securities. These companies take money from the public and invest in various securities and financial products. Thereafter, the company deducts its operational cost or expense ratio from the earned profit, and later profit is distributed to shareholders. Bajaj Alliance General Insurance Company, IDFC, and HDFC mutual fund are popular examples.

3. Loan Company: Loan Company as its name suggests, is a financial institution that offers loans for various purposes other than of the AMC which includes the Housing Finance Firms. LIC Finance Ltd, PNB Housing Finance Firm, and HDFC are some popular examples.

4. Infrastructure Finance Company: It is a Non- Banking Finance Company, that deploys three-fourths of its total assets in infrastructure loans and has a minimum Net Owned Fund of 300crores and That has minimum ‘A’ credit rating or equivalent CRAR of 15% Few examples are GMR infrastructure ltd, Hindustan Construction Company. IFC’s finance projects in sectors of power, roads, telecommunication, etc.

5. Systematically Important Core Investment Company: It is a NBFC that deploys 90% of its total assets in the form of investment in shares, stocks, debt, or loan group companies. Out of a total of 90%, 60% of the total assets should be invested in equity shares or those which compulsorily converted later into equity shares.

6. Infrastructure Debt Fund: IDFs raise resources through bonds for long-term infrastructure projects. The bonds are issued in multiple currencies to ensure that have they a five–year maturity for investors.

7. Microfinance Company: People in the urban, semi-urban, or rural areas of India need financial help to start their business and fulfill other requirements but they are hesitant to seek help from banks because of the formalities that need to be fulfilled to get the required money. Now, here the microfinance company comes out, and they provide financial help to these underprivileged people. Bandhan Financial Service Ltd and Ujjivan Financial Service are a few examples.

8. NBFC (Factor): These types of NBFCs in India are low. These companies usually buy loans at a much discounted rate from lenders and after that, they adjust the repayment table of the debtor to ensure a facile settlement adding a small profit.

9. Mortgage Company: It is a financial institution where at least 90% of the business turnover is of mortgage guarantee or at least 90% of the gross income is from mortgage guarantee business or net owned fund is 100 crores.

10. Non-Operative Financial Holding Company: It is a separate category of NBFCs which is a wholly owned non-operative financial holding company permitted to set up or hold the bank as well as another financial service with the permission of RBI under applicable regulatory prescription.

Examples of NBFCs

1. Bajaj Finserv: Bajaj Finserv is a leading non-banking finance company (NBFC) in India, which offers a wide range of financial services across various sectors such as lending, insurance, and wealth management. With a diverse portfolio of products and services. Bajaj Finserv has become one of the most trusted NBFCs in the country.

2. Muthoot Finance: Muthoot Fincorp is an NBFC that specializes in providing financial services to individuals, and small businesses, and it is quite popular in the rural communities in India. Muthoot Fincorp was established in the year 1997, Muthoot Fincorp’s holding group is Muthoot Pappachan Group and has grown widely and is also popular in offering gold loans.

3. Aditya Birla Capital: It is one of the prominent non-banking financial companies (NBFC) in India, ABC provides a diverse range of financial services including lending, insurance, wealth management, asset management, and capital management. The company has a wide presence across India, with over 700 branches and 135,000 distribution partners.

4. L&T Finance Holdings Limited: L&T Finance Holdings Limited is among the leading NBFCs in India, the net worth as per records is over US$12 billion. The company operates primarily in the financial services industry, their market offering includes a range of products and services such as asset finance, infrastructure finance, and rural finance. Apart from finance, L&T Holdings has a significant presence in infrastructure, power, and energy sectors as well.

Advantages of NBFCs

1. Minimal Documentation: NBFCs have smoothened the loan and advance mechanism, as they are making efforts to create a loaning facility paperless, as of now they have minimised the documentation requirements and are also offering paperless and zero documentation loan offers.

2. Competitive Interest Rates: NBFC offers lower interest rates for a business loan in some conditions, and their competitive rates in the financial sector attract the borrowers to lend money from them rather than going through the route of banks. Also, loan processing and other file charges are also low and sometimes they also waive these charges.

3. Easy Eligibility Criteria: This is the most important and unique advantage of choosing an NBFC. Banks usually have strict lending criteria for providing business loans, they even follow priority criteria. They follow a long and tough verification process and lots of documentation for approving business loan applications.

4. Quick Fund Disbursal: NBFCs follow less stringent lending terms. They have relaxed eligibility criteria and they have minimised documentation. Hence, their business loans are disbursed more quickly, which allows businesses to get quick funding when they need it the most.

5. Pre-Approved Loan Limit: NBFCs provide business loans and personal loans with pre-approved loan limits. Businesses and individuals can withdraw funds from pre-approved loan limits as and when required. The best part about this offering is that interest will be charged only on the amount that is used by the business and not on the entire loan limit provided to them.

Disadvantages of NBFCs

1. Over-Indebtedness: NBFCs can cause low-income people to become excessively indebted. Borrowers might take out several loans from several NBFCs as there are pre-approved loan offers given to them, which could put them in a debt trap situation and make it impossible for them to repay the debt and they will fall in debt cycle to repay.

2. Harsh Repayment Method: Many customers of NBFCs are low-income people who use NBFC’s are uneducated in financial matters. They might just fall for taking out loans, which they can’t afford since they don’t completely comprehend the terms and circumstances of the loan. NBFCs have less control over them and sometimes they use unlawful and harsh methods to recover the loan.

3. High-Interest Rates: NBFCs have seen a huge drawback in the form of high-interest rates. NBFCs have charged as high as 30%. Despite offering convenient and swift loan services, the elevated interest rates dissolve the attractiveness of these offerings to potential clients.

4. Lack of Defaulter Database: NBFCs are susceptible to credit risk as there is a lack of vital information. Additionally, there is a need to bring essential legislative amendments that can leverage the utility payments database in the credit assessment process.

Difference between Banks and NBFCs

Basis Banks NBFCs
Meaning A bank is a government authorised company, which provides banking services to the general public. An NBFC is a company engaged in financial services without a banking license.
Regulatory Act Regulated by the RBI under the Banking Regulations Act, 1949. Regulated by the RBI, incorporated under the Companies Act, 1956.
Functions Banks offer a wide range of banking services. NBFC is engaged in lending and investment activities.
Deposit Acceptance Banks are allowed to accept deposits from the general public. NBFCs are not allowed to accept demand deposits from the general public.

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