What is NBFC and its Types & Role? How do NBFC make money & why it is popular than bank | Bank VS NBFCs

NBFCs (Non-Banking Financial Companies) deliver financial products and services similar to a lot of what a bank would do, including loans, credits, and other investments. However, there are some significant differences. For starters, NBFCs cannot accept deposits from the general public, and, because of that, you cannot open a saving or current account with an NBFC. NBFCs can offer various kinds of products and services, including an NBFC for infrastructure funding, an NBFC for small business loans, an NBFC for investment management, an NBFC for financing vehicles/gadgets, etc. NBFCs are vital to the economy because they can fund sectors and people whom banks don’t fund enough, and they help drive economic growth and financial inclusion. In many cases, NBFCs have captured market share from banks because they can provide faster, more flexible structures and specific needs for consumers.

What is an NBFC?

A Non-Banking Financial Company (NBFC) is a financial organization that provides financial and banking services without having a banking license. Registered with the Companies Act, 1956 (or 2013 in India), and regulated by the Reserve Bank of India (RBI) under the RBI Act, 1934, NBFCs are similar to banks in that they cannot take demand deposit (savings or current accounts), but they can provide loan, investment, and other financial products.

Types of NBFCs

Infrastructure Finance Company (IFC):

An Infrastructure Finance Company (IFC) is a specialized type of financial institution providing financing for large-scale, long-term development projects that a developing economy relies upon. They are your lenders of last resort to build essential infrastructure; infrastructure that is rarely cost-effective for a normal bank to finance.

For example, if a private company wants to build a new 100-kilometer toll highway, it will take approximately five years to build, and revenue will only start when the road opens publicly, regardless of the upfront cost. A typical bank relies on short-term public deposits, and knows that the investment in the highway is simply too long-term and too risky due to lack of guaranteed imminent revenue, even if the road is completed on time. An IFC is purposely set-up to assist private company projects, for example, it would step-in and provide the large loan needed to build the toll road knowing that it would have to wait for revenue to come in from toll payment over a decade or more. IFCs are loaners, but they also are partners helping build and develop a nation, one project at-a-time.

Housing Finance Company (HFC):

A Housing Finance Company (HFC) is a specific kind of Non-Banking Financial Company (NBFC) with a single purpose: to provide loans for purchasing, constructing, improving, or repairing housing. Think of it as a finance company that lives and breathes real estate because all it does is help families and individuals become homeowners. It is different from a bank that provides a full range of services from savings accounts to business loans. An HFC will put just about every dollar it can raise back into the housing industry.

For example, if a newly married couple found an apartment that was perfect for them and wanted to purchase it but needed financing, they would go to an HFC for the home loan. The HFC would assess the couple’s suitability for the loan, and if they were qualified, the HFC would give them the money they needed. The couple would then pay back the loan, which would be combined into a likely 15-to-20-year monthly installment plan or EMI, which includes a profit margin the HFC builds into the loan. HFCs serve as an important leg of the real estate industry by providing products to make housing affordable and more attainable, generally providing competing terms, and an understanding of the property market that is likely more in-depth than a traditional bank.

Investment Company (IC):

An Investment Company (IC) is a financial institution that behaves as a professional money manager for a group of investors, pooling their investment funds into a diversified portfolio of securities, for example, stocks, bonds and other investments. Think of it as a way for individuals who do not have the time, expertise or wealth to invest in the financial markets to do so in an effective manner, and with less risk. Instead of trying to pick winning stocks on your own (which is risky and complicated), you buy shares or units in the Investment Company. Your money is then pooled with money from thousands of other investors, and a team of professional fund managers, who you pay to manage the fund, will use this large pool of capital to buy a large assortment of investments.

For example, when you make an investment in a mutual fund scheme, you are investing in an Investment Company. The investment company uses the money from you, and all other investors, to purchase shares of dozens of different companies, thus spreading out the risk. If one company in the portfolio does poorly, the other companies are making money, and thus offsetting any loss. The IC generates revenue through fees for its management services, providing investors access, professional management, and the key benefit of diversification, which is a foundation of modern personal investing.

NBFC-ND (Non-Deposit Taking NBFC):

A Non-Deposit Taking NBFC (NBFC-ND) is a category of financial company that is defined by what it cannot do, and that is it cannot accept fixed or savings deposits from the public. This is the most important difference that distinguishes it from a bank. A Non-Deposit Taking NBFC operates as a financial intermediary that uses its own capital, or funds it raises from sources such as banks and the capital markets, to provide loans and other services, but it is never going to ask the average person to open a savings account with it. This fact makes it inherently less risky to depositors, because there is no risk of the depositor losing their savings if the Non-Deposit Taking NBFC fails.

As a perfect example, you can think of a company that makes loans for people to buy a car or a refrigerator. That company is not making that loan because it took money out of your neighbor’s savings account; it is borrowing money from somewhere else, likely a bigger bank, or it has money invested through its promoters. Because Non-Deposit Taking NBFCs do not have the low-cost, stable funding base that banks do, they typically have a slightly higher rate of interest on their loans.

NBFC-D (Deposit-Taking NBFC):

A Deposit-Taking NBFC (NBFC-D) is an entity that can accept fixed deposits from the public, similar to bank deposits. However, it has restrictions. An NBFC-D cannot offer current or savings accounts, which means deposits cannot be accessed on demand or broken into without notice. Instead, they accept fixed term deposits (like a 1-3 year term deposit) and lend this money out to other customers. They charge a higher interest rate on loans than they pay on deposits. However, deposits are not guaranteed, which is what you want to look for a bank. You should check the company’s credit rating, and overall financial health before making an investment.

Asset Finance Company (AFC):

An Asset Finance Company (AFC) is a type of Non-Banking Financial Company (NBFC) that focuses primarily on providing loans for the acquisition of physical assets that generate income or are used to earn a living. To put it simply, an AFC does not provide you with cash; you are essentially asking it to finance the equipment or machinery that you need to run or grow your business. In essence, the loan is secured based on the asset that you are acquiring. Think of themselves as a financier that believes in the earning potential of the machine.

A perfect example is financing a truck. When someone wants a truck to start a transport business, they typically inquire with an AFC. The AFC will pay the vehicle manufacturer or dealer directly, while the borrower, who owns the truck, will start paying the AFC in monthly installments. While the loan is in place, the truck is collateralized. If the money is not repaid, the AFC has the right to reclaim the truck and sell it to recover their money.

Loan Company (LC):

A Loan Company (LC) is a variety of a Non-Banking Financial Company (NBFC) which works as a straightforward, specialized lender, whose main business is providing loans and advances for purposes that are not its own main business. In other words, if the NBFC’s main business is not asset financing, financing for community and infrastructure development or housing financing either broadly or specifically, just giving out loans in many different forms, it is an LC.

Consider a Loan Company like a financial store selling “money as a product.” It is different from an Asset Finance Company which is financing a specific truck or from a Housing Finance Company which is exclusively a mortgage lender. The LC would allow you to borrow money for any use, represented or secured by guaranteed cash flow or income from other routes, such as unsecured personal loans for a wedding in cash, business loans for working capital, or unsecured loans to individuals based on creditworthiness rather than collateral such as property or equipment. An LC also does not fund itself from public deposits, but instead, uses fund sources from their promoters, banks, or capital markets, and lends out their funds at a markup interest rate. The profit of an LC comes primarily from the spread between their costs of funds and the interest from the borrowers.

Systemically Important Core Investment Company (CIC-ND-SI):

A Systemically Important Core Investment Company (CIC-ND-SI) is basically a huge, professionally-managed family fund, which takes long-term positions in a group of linked companies, and is so big that if it were to fail, the financial system as a whole could be at risk, which is why the Reserve Bank of India (RBI) has strict regulations on it. a very large business family, let’s call them the “ABC Group”, has companies in steel, power, and real estate. To manage its investments across these various different businesses in a centralized way, the ABC Group creates a special company and we’ll call that company “ABC Investments Core”.

This company does not do business, nor does it lend to the general public, its singular role is to take the money it has raised from the banks and the general public, and (1) buy stock of the various other companies in the group, and (2) hold long-term control positions in other companies in the group, and generally focus on the overall returns of the group as a whole and not on the financial performance of the company’s individual holdings. ABC Investments Core has a very large balance sheet, it could have hundreds and hundreds of crores in total assets and borrow money from the market, so a failure of ABC Investments Core would affect the banks and other institutions that competently loaned money to the ABC Investment Core.

Factoring Company:

A factoring company is a financial institution that will purchase unpaid invoices to assist companies with their cash flow. For instance, consider a small manufacturer that has just delivered a big order to a large retailer. The manufacturer will most likely wait 60 or 90 days to receive payment from the retailer when at that time, they could sell the invoice to a factoring company at a small discount instead. The factoring company would essentially give the manufacturer the value of 80% of the invoice immediately. This gives the manufacturer the immediate cash flow to pay employees, to purchase more raw materials, and to fill out new orders. The factoring company will then take over the responsibility of collecting the invoice from the retailer.

When the retailer pays the factoring company, the factor sends 20% of the invoice to the manufacturer after they take a fee for the service. A factoring company acts as a cash-flow manager because they relieve businesses of the burden of waiting to be paid and allow their sales on paper to be accessed as working capital for the growth of the business.

Microfinance Institution (MFI):

A Microfinance Institution (MFI) is a type of financial entity whose mission is to provide small loans and other basic financial services to low-income people or groups who otherwise may not have access to traditional banking. It is similar to a lender whose job it is to uplift the smallest entrepreneurs on the periphery of the economy, a vegetable dealer who needs money to buy a bigger cart, businesswoman who needs money to buy a sewing machine, or a farmer who needs money to buy seeds before the harvest. These lenders do not have collateral or do not have a formal job status with paystubs that meet the requirements of a bank. Instead, MFIs find creative ways, typically by organizing the borrowers into small, local bonds, where they essentially guarantee loans to one another.

The process is almost always simple and quick, loaning a limited amount of money with the understanding that all loans will be repaid in small, frequent installments. Interest rates are typically higher than bank rates to cover the higher expense of managing lots of very small loans. However, the principle of an MFI is to achieve financial inclusion; providing a lifeline for those in informal economies to start or grow their small business so they become self-sustaining businesses, a path out of poverty.

Role of NBFCs

• Credit Accessibility: NBFCs help to connect individuals and businesses that may not be able to get loans with traditional banks, particularly in rural or semi-urban areas.
• Economic Development: NBFCs contribute to economic development by financing SMEs, infrastructure, and micro-enterprises.
• Specialized Products: NBFCs will offer specialized products like vehicle loans, gold loans, or microfinance to specific target segments.
• Financial Inclusion: NBFCs will serve the unbankable population with flexible lending models, such as microfinance, to low income groups.
• Products: NBFCs have provided new and innovative financial products and technology to speed up the loan disbursal process.

How NBFCs Make Money

• Interest Income: The main source, garnered from the interest applied to provided credit (including personal loans, automotive, or business loans). Interest rates are often higher than banks due to the risk profiles associated with borrowers.
• Fee Income: Fees that arise from processing fees, documentation fees, or fees as evidenced by prepayment penalties.
• Investment Income: Income generated from investing in securities or mutual and other funds.
• Factoring Services: Tribute for the purchase of receivables at a discounted rate, receiving a margin on collection.
• Asset Management: Managing client portfolios or a mutual fund in exchange for an ongoing fee.
• Cross-Selling: Offering insurance or other financial products that firms provide in conjunction with partners.

Why NBFCs Are Popular Compared to Banks

• Flexible Lending Norms: NBFCs have relatively lighter eligibility requirements, providing loans to people with low credit scores or banking-related history.
• Faster Loan Processing: The streamlined process and data-driven business model allow for facilitated loan approvals and disbursement.
• Specialized Products: NBFCs serve niche segments (e.g. gold loans, microfinance) that banks typically won’t serve.
• Wider Reach: NBFCs operate in rural and semi-urban areas that have low bank penetration.
• Customer-Centric Approach: NBFCs offer a customer experience that allows for personalized services and flexibility in repayment.
• Less Regulatory Burden: NBFCs have fewer regulations than banks to encourage operational flexibility (but they are still regulated by the RBI).

Bank vs. NBFCs

Aspect	Banks	NBFCs
Definition	Licensed to accept demand deposits and provide a wide range of services.	Cannot accept demand deposits; focus on loans and specialized services.
Regulation	Heavily regulated by RBI under Banking Regulation Act, 1949.	Regulated by RBI but with fewer restrictions under RBI Act, 1934.
Deposit Acceptance	Accept demand (savings/current) and fixed deposits.	Only some NBFCs accept fixed deposits; no demand deposits.
Loan Processing	Slower due to strict compliance and documentation.	Faster, with flexible eligibility and minimal paperwork.
Interest Rates	Lower (e.g., 6-12% for loans), due to access to low-cost deposits.	Higher (e.g., 12-24%), as they rely on borrowed funds or market sources.
Credit Access	Strict credit checks; prefer high-credit-score borrowers.	Lenient; serve underserved or high-risk borrowers.
Services Offered	Broad (loans, deposits, cards, forex, etc.).	Specialized (loans, investments, microfinance, etc.).
Capital Requirements	High (e.g., ₹500 crore for new banks as per RBI).	Lower (e.g., ₹2 crore for NBFCs, though varies by type).
Risk	Lower risk due to deposit insurance (DICGC up to ₹5 lakh).	Higher risk; no deposit insurance for NBFC deposits.
Reach	Extensive branch networks but limited in remote areas.	Strong presence in rural/semi-urban areas for specific products.

Conclusion

Non-Banking Financial Companies (NBFCs) contribute significantly to financial inclusion and economic growth by complementing banks with their specialized services and wider reach. While NBFCs primarily earn their revenues through interest and fees on loans made, NBFCs carry a relatively greater risk position largely tied to the way they raise discretionary funding from investors. Banks are generally recognized for their stability, greater service offerings and overall financial position as compared to their NBFC counterparts; however, they are often more cumbersome, restrictive and slower to serve customers, often causing potential financial borrowers to consider NBFCs to service the wider population in underserved sections of the economy. The decision to work with banks versus working with NBFCs is highly contingent upon the particular customer situation, credit profile, needs and the urgency of their funding requirement.

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