How Do NBFCs Differ from Banks?

Posted in Investment By Sajhyadri Chattopadhyay - Feb 17, 2023
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Beyond the traditional banking system, non-banking financial companies (or NBFCs as they are commonly called), form the second most dominant type of financial intermediaries in a country’s macroeconomic setup. Both banks and NBFCs are key to the overall financial portfolio available in India, offering almost similar kinds of services to customers. However, the two systems have some key pros and cons in terms of activities, norms, regulations, etc.  

NBFC entered India’s private and public sectors to support traditional banks with financial solutions as the latter alone could not freely cater to the entire society. They helped to bridge this gap between financial institutions and people who were met with closed doors due to several reasons. Banks and NBFCs have diverse differences with respect to the different services they provide, how they are registered or incorporated with governing bodies, regulatory guidelines they follow, etc.  

Through the Looking Glass: NBFCs

A non-banking financial company is registered under the Companies Act of 1956 and is regulated under the RBI Act of 1934. Thus, it is regulated by the Reserve Bank of India. While such entities are not sub-types of banks, they perform lending and other financial activities, similar to traditional banks. Their portfolio includes several kinds of loans, savings schemes, investment products, credit facility, market-linked trading instruments, insurance products, cards, etc.  

Through the Looking Glass: Banks

Banks are government authorised financial institutions that can conduct a wider array of banking activities like granting credit, accepting deposits, clearing cheques, paying interest, managing withdrawals, apart from general utility services to citizens. Banks are widely looked upon as the foremost organization that functions at the top of the financial pyramid of a country. They act as the primary intermediary between the borrower and the depositors. Overall, they make sure that our economy operates smoothly.  

Chalk and Cheese

Just like banks, NBFCs allow activities like borrowing and investing; however, the three main functions in which NBFCs differ from banks are as follows –  

  • NBFCs are not allowed to accept demand deposits;  
  • NBFCs cannot issue cheques that are drawn on itself;  
  • NBFCs cannot provide the deposit insurance facility offered by the Deposit Insurance and Credit Guarantee Corporation (DICGC).  

All these operational differences function as drawbacks of such corporations. Banks on the other hand, do not have these restrictions and can freely function in the above three areas.  

Face to Face 

Beyond the above distinctions, banks and NBFCs have a number of finer differences. Understanding these help us to decide which financial institution to approach for a certain activity.  

  • Banks make up an integral part of the payment and settlement system whereas NBFCs are not a part of it.  
  • All NBFCs are allowed to take up to 100% foreign investments, while only the private sector banks are eligible for foreign investments, with a limit of 74%.  
  • Banks actively participate in the creation of credit, while NBFCs do not.  
  • NBFCs do not have to maintain any reserve ratio such as Cash Reserve Ratio (CRR) or Statutory Liquidity Ratio (SLR), while banks must mandatorily maintain these reserve ratios.  
  • Banks are eligible to provide a number of transactional services to customers, like offering overdraft facility, issuing traveller’s cheque, transferring funds, etc. NBFCs cannot provide these services.  

Deposit Acceptance

In India, only a limited number of NBFCs can accept deposit. As of September 2022, there are less than 100 deposit-accepting NBFCs (commonly termed ‘NBFC-D’) out of almost 10,000 NBFCs registered under the RBI. Although these handful NBFCs can accept deposit from the public just like banks do, they are not allowed to accept demand deposits. People can only open such demand accounts, such as current accounts, with commercial banks.  

Financial Regulation 

In terms of financial supervision, the RBI has strict regulations imposed on banks as per the Banking Regulation Act of 1949. This is mainly because they deal with public deposits. On the other hand, the RBI Act of 1934 and its periodic amendments regulate the operations of NBFCs in India. Banks have deeper and more complex functioning norms compared to NBFCs. The logic behind this is that a financial institution which accepts public deposits must be highly regulated, as the safety and security of the common people’s money is of the highest concern to the RBI.  

Banking Banes

Individuals who have a poor credit score find it extremely difficult to get a loan from any bank even if they are willing to pay a higher interest rate. Traditional banks have fixed lending rates as well as specific sums that they can lend. They cannot extend beyond these stipulated norms and guidelines due to their capital requirements. Banks that conduct business with foreign parties have a significant impact on the country’s market and economy due to a fluctuation in currency exchanges every now and then. The dollar being a strong standpoint of competition for major currencies, it restricts banks from going beyond a certain leniency. Moreover, service charges have increased over the years, making it more expensive for commoners to deal with traditional banks.  

The Rise of NBFCs

On the flipside, NBFCs have not only carved out a niche in the country’s high-stakes financial domain but have also grown and improved over the years. They have much more relaxed guidelines in terms of lending and other banking services, which has given them an edge. Sure, they charge a higher interest rate for this accessibility, but when you are faced with a financial emergency and banks are shutting their doors on your face, it is not a choice. NBFCs approve your loan or credit application faster than banks and it can be done completely online. They can provide a relief to your cash crunch irrespective of your credit score. Furthermore, NBFCs have higher flexible unsecured lending and repayment options.  

The People’s Choice

In recent times, the RBI has taken steps to increase the security of citizens’ credit and finances under NBFCs by imposing stricter regulations on them. These institutions have not only risen to the challenge but are also becoming a popular financial go-to. Another reason for this is because NBFCs provide higher return rates with saving schemes like Fixed Deposits. With a better use of modern technology and improved customer outreach than traditional banks, their importance is steadily growing. In a country strict about following time-tested financial ventures, the continued popularity of NBFCs is in itself a verified mark of success.  

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