ROLE OF NON BANK FINANCIAL INSTITUTIONS (NBFCs)

Abstract:

Non-Banking Financial Institutions (NBFCs) are companies registered under the Companies Act, 1956 which basically perform lending function to the public and differ from the banks in the sense that they cannot accept deposits from the public. They offer various banking services but do not have a banking license. They are not subject to banking regulations and oversight by federal and state authorities adhered to by traditional banks. Since the Great Recession, NBFCs have proliferated in number and type and play a key role in meeting the credit demand unmet by traditional banks. Examples of NBFCs include investment banks, mortgage lenders, money market funds, insurance companies, hedge funds, private equity funds and P2P lenders.

Introduction:

In the 1960s, NBFCs humbly started in India as an alternative for savers and investors whose financial needs were not sufficiently met by the existing banking system. In the first stages of development, the Companies Act regulated financing, however, there was a need for a separate regulatory mechanism. Since then the RBI has taken measure to regulate the NBFCs. Between the year 1980s to 1990s, they grew a large investor base which made the RBI feel the need to regulate the industry. Since then there have many changes in the RBI Act which have helped NBFCs grow significantly in terms of operations, range of instruments, market products and technological advancements. In 2016, they got the go-ahead for Foreign Direct Investment by the union cabinet. They are now an integral part of the Indian financial system.[1]

Just like banks, NBFCs give out loans but unlike them, they do not directly take deposits from the public. They borrow from banks and sell commercial papers which are short term financial securities, which debt mutual funds buy. In the last two years, the share of bank borrowing as a proportion of the total borrowing of the NBFCs has gone up which has led to a major NBFC crisis. [2]

Difference between NBFCs and Banks:

  1. NBFCs do not hold a banking license though they provide banking services.
  2. NBFCs cannot accept demand deposits.
  3. An NBFC is not a part of the payment and settlement system.
  4. An NBFC cannot issue cheques drawn on itself.
  5. Unlike banks, deposit insurance facility of the Deposit Insurance and Credit Guarantee Corporation is not available for NBFC depositors.
  6. Reserve Ratios (CRR, SLR etc.) need not be maintained by the NBFCs.
  7. 100% foreign investment allowed.

Types of NBFCs in India:

  1. Investment and Credit Company (ICC) – financial institution carrying on as its principle business asset financing.
  2. Infrastructure Finance Company (IFC) – mainly provides infrastructure loans.
  3. Infrastructure Debt Fund–NBFC – facilitates the flow of long term debt into infrastructure projects.
  4. NBFC-Factors – principle business of factoring. Factoring is a financial transaction and a type of debtor finance.
  5. Gold loan NBFCs in India – mainly provide gold loans.
  6. Residuary Non-Banking Companies – principle business includes receiving deposits, under any scheme or arrangement or in any other manner and not being investment, asset financing or loan company.
  7. Account Aggregators (AA) – takes the business of account aggregation for a fee or otherwise.

Role of NBFCs:

Non-Banking Financial Companies play a variety of roles in the financial system of a country and aid economic development in various ways. Some of the functions include:

  • They promote the inclusive growth of a country by fulfilling the credit needs of the bank excluded customers.
  • They aid Micro, Small and Medium (MSME) enterprises through innovative financial services suitable to their requirements.
  • They help in the overall development of the economy by providing a fillip to transportation, employment generation, wealth creation, bank credit in rural areas and by supporting the financially weaker sections of the society.
  • They play the vital role of channelizing scarce financial resources to capital formation.
  • They provide financial assistance and guidance to customers in matters relating to insurance.
  • They provide services relating to loans and advances, acquisition of shares, bonds, stock, debentures, security issued by government or local authority or other securities of like marketable nature, leasing, hire-purchase, insurance business, chit business.
  • They supplement the banks in meeting the increased financial needs of the corporate sector and in aiding unorganized sector and small local borrowers.

Besides these functions, the NBFCs play some other roles also-

  • They convert savings into investments, thus helping in the mobilization of resources.
  • They have the provisions for long-term credit and specialized credit.
  • They help in attracting foreign grants and in developing financial markets by catering to the urban and poor rural companies and playing a complementary role in financial inclusion. These financial companies bring much-needed diversity to the market by diversifying the risks, increasing liquidity in the markets thereby bringing efficiency and promoting financial stability.
  • They serve as a government instrument by breaking the vicious circle of poverty.[3]
  • In terms of year-on-year growth rate, the NBFC sector beats the banking sector in contributing to the economy every year.
  • They offer cheaper credits to the customers as compared to the banks as a result of which the money lent by the NBFCs is higher than that of the banking sector.
  • Since their inception, NBFCs have contributed more to infrastructure lending than the banks.
  • NBFCs collaborate with the government for the upliftment of the society. They convert the deposits from the general public to industrial capital which raises the demand for workforce and as a result creates employment opportunities. This works to upgrade the living standards of the society. [4]

Conclusion:

Needless to say, NBFCs continue to play a quintessential role in a country’s growth story. The funding received from these companies is the light many individuals and businesses hold on to in order to tread fast. The banking sector has always been the most important field of business because of its credibility in aiding manufacturing, infrastructural growth and even being a backbone for an individual’s money but despite this, NBFCs play a critical role and their presence helps the economy grow in the right direction.

References

[1] <https://www.nelito.com/blog/History-of-Non-Banking-Financial-Institutions.html#:~:text=NBFCs%20started%20humbly%20in%20India,impact%20on%20the%20financial%20industry.>&nbsp; Accessed  2 June,2020

[2]< https://www.livemint.com/industry/banking/how-easy-money-from-banks-led-nbfcs-into-crisis-1562520422782.html>accessed 2 June, 2020

[3] <https://www.nelito.com/blog/the-role-nbfcs-in-indian-economy.html#:~:text=NBFC%20focuses%20on%20business%20related,%2C%20insurance%20business%2C%20chit%20business.>&nbsp; accessed 4 June, 2020

[4]< https://nbfclicenseindia.com/blog/nbfc-role/ > accessed 5 June, 2020

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