Chapter Notes: Non-Banking Financial Companies (NBFCs)
Non-Banking Financial Companies (NBFCs)
Non-Banking Financial Companies (NBFCs) are financial intermediaries registered as companies under the Companies Act that provide a range of financial services but do not have a full banking licence. NBFCs perform many functions similar to banks (such as lending and investment) but differ from banks in certain legal, operational and regulatory respects.
Key definition
Non-Banking Financial Company (NBFC) means a company that is engaged in the business of one or more of the following: loans and advances; acquisition of shares, stocks, bonds, debentures or other marketable securities; leasing; hire-purchase; chit business; and similar financial activities. It excludes companies whose principal business is agricultural or industrial activity, purchase or sale of goods (other than securities), providing services, or sale/purchase/construction of immovable property.
The definition also covers a non-banking institution that is a company and whose principal business is the receiving of deposits under any scheme or arrangement (commonly referred to as a Residuary NBFC).
NBFCs are regulated by the Reserve Bank of India (RBI) under Chapter III-B of the Reserve Bank of India Act, 1934, and must obtain a Certificate of Registration (CoR) from the RBI to commence or carry on the business of a non-banking financial institution. They are required to have minimum Net Owned Funds (NOF) (the input reference gives the statutory minimum as Rs. 2 crore).
Principal legal and operational distinctions between NBFCs and banks
- NBFCs are not part of the payment and settlement system: they cannot issue cheques drawn on themselves and do not have the same deposit-taking and payment system privileges as banks.
- NBFCs cannot borrow from the RBI or access RBI liquidity support in the same manner as banks (except as permitted by specific regulations).
- Deposit-taking NBFCs are regulated differently from banks: separate prudential and reporting norms apply.
- Depositors with NBFCs do not have deposit insurance cover from the Deposit Insurance and Credit Guarantee Corporation (DICGC), unlike bank depositors.
Evolution and recent milestones
NBFCs in India began in a small way in the 1960s to meet savings and investment needs not satisfied by the banking system. Initially regulated by the Companies Act, their role expanded over the following decades - accepting fixed deposits, providing lease and hire-purchase finance, and serving customers in semi-urban and rural areas.
As the sector grew and the number of NBFCs rose substantially (from a few thousand in the early 1980s to tens of thousands by the early 1990s), the RBI and government introduced a dedicated regulatory framework. Key milestones include:
- 1975: Recommendations (James S. Raj Study Group) permitting hire-purchase and leasing companies to accept deposits to the extent of their Net Owned Funds and to maintain liquid assets.
- 1992-1997: Committees (including the A. C. Shah Committee) recommended stronger regulation. Major amendments to the RBI Act (1997) created a more comprehensive regulatory and supervisory structure for NBFCs.
- 2006-2007: Introduction of a Fair Practices Code and a Corporate Governance framework for NBFCs.
- 2016: Government allowed foreign direct investment under the automatic route for regulated NBFCs.
- 2021: RBI's Integrated Ombudsman Scheme extended grievance redress coverage to NBFCs subject to exclusions and specific conditions.
- 2022: RBI communications clarifying bank finance to NBFCs and related prudential considerations.
Role of NBFCs in financial inclusion and the economy
NBFCs play an important role in broadening access to financial services, especially in underbanked rural and semi-urban areas. Their strengths include:
- Greater reach and proximity to customers, enabling them to cater to low-income and informal-sector borrowers.
- Product innovation and flexible delivery models suited to local needs.
- Competition to banks in specialised segments, improving consumer choice and efficiency in the financial system.
- Microfinance institutions (many organised as NBFC-MFIs) providing small-ticket credit and livelihood support to households often considered unbankable by traditional banks.
Classification of NBFCs
NBFCs may be classified in several ways: by liabilities accessed, by activity undertaken, and by size/systemic importance.
Liability-based classification
Broadly, NBFCs are classified into deposit-taking and non-deposit-taking NBFCs. Deposit-taking NBFCs are subject to additional prudential norms (capital adequacy, maintenance of liquid assets, exposure limits, ALM discipline, regulatory reporting, etc.).
Activity-based classification
Common activity-based categories include:
- Asset Finance Companies (AFCs) - primarily engaged in financing physical assets (vehicles, machines, etc.).
- Loan Companies (LCs) - provide loans and advances but do not principally engage in asset finance or investment business.
- Investment Companies (ICs) - hold securities for investment purposes.
- Infrastructure Finance Companies (IFCs) - specialise in infrastructure lending and have minimum qualifying norms for capital and asset composition.
- Core Investment Companies (CICs) - hold investments in group companies and may be systemically important if large enough; treated differently under regulation.
- Infrastructure Debt Fund - NBFC (IDF-NBFC) - set up to channel long-term debt into infrastructure projects.
- NBFC-Microfinance Institutions (NBFC-MFIs) - provide microcredit to low-income borrowers.
- Residuary NBFCs (RNBFCs) - whose principal business is receiving deposits under various schemes (often small-ticket deposits).
- NBFC-Factors - engaged in factoring business.
- Non-Operating Financial Holding Companies (NOFHC) - holding companies for financial services groups (subject to RBI directions).
- Mortgage Guarantee Companies (MGC) - provide mortgage guarantees.
- Account Aggregators (NBFC-AA) - entities that facilitate consent-based sharing of financial data.
- Peer-to-Peer Lending Platforms (NBFC-P2P) - facilitate person-to-person lending through an online platform and are regulated as NBFCs.
Size-based / systemic classification
Non-deposit-taking NBFCs with assets of Rs. 500 crore and above are generally classified as systemically important NBFCs (NBFC-ND-SI). These entities are subject to enhanced prudential regulation - capital adequacy, exposure norms and additional reporting requirements - reflecting their potential systemic impact.
Registration, capital and prudential requirements
Under Section 45-IA of the RBI Act, a company must obtain a Certificate of Registration (CoR) from the RBI to commence or carry on NBFC business. Key statutory and prudential requirements (as reflected in the input) include:
- Net Owned Funds (NOF): Minimum Net Owned Funds requirement - the input refers to a threshold of Rs. 2 crore as a minimum to qualify as a registered NBFC.
- Reserve fund: NBFCs are required to create a reserve fund and transfer not less than 20% of their profits to that fund annually.
- Maintenance of liquid assets: Deposit-taking NBFCs must maintain a specified percentage of assets in unencumbered approved government securities.
- Capital adequacy: Systemically important NBFCs and other specified categories must meet capital adequacy norms prescribed by the RBI.
- Exposure norms and ALM: Limits on single/group exposures, investment in land/building/unquoted shares, and Asset-Liability Management discipline are applied as appropriate.
- Income recognition and accounting: RBI prescribes norms relating to income recognition, provisioning, and accounting standards applicable to NBFCs.
- Regulatory powers: RBI can issue directions to NBFCs or their auditors about preparation of financial statements, require a special audit, prohibit alienation of assets, and file winding-up petitions where necessary.
Regulatory oversight, reporting and compliance
The RBI's power to regulate NBFCs was significantly strengthened by amendments to the RBI Act in 1997. Salient regulatory and compliance requirements drawn from the input include:
- Mandatory registration with the RBI for NBFCs that fall within the RBI's purview.
- Deposit-taking NBFCs subject to requirements for maintenance of liquid assets, limits on acceptance of deposits, and public disclosure.
- Obligations to submit statutory returns: annual audited balance sheets, periodic returns on liquid assets, and specific deposit returns (for example, the NBS-1 return).
- Obligation to obtain and maintain credit ratings periodically (the input states credit rating every six months) and to submit ratings to the RBI.
- Half-yearly ALM return requirement for NBFCs that have public deposits of Rs. 20 crore or more or total assets of Rs. 100 crore or more.
- Prohibition on offering certain incentives or additional benefits to depositors beyond what banks offer, as a consumer-protection measure.
- Requirement to maintain a minimum proportion (input gives 15%) of public deposits in liquid assets for eligible NBFCs.
Guidelines on deposits and customer protection
Some operational guidelines for NBFCs (as indicated in the input) are:
- NBFCs are not authorised to accept demand deposits from the public.
- The minimum tenure for public deposits is 12 months and the maximum tenure is 60 months (as per the input reference).
- The RBI does not guarantee repayment of amounts taken by NBFCs; depositors do not enjoy deposit insurance cover from DICGC when funds are placed with NBFCs.
- NBFCs should not charge an interest rate higher than any rate prescribed by the RBI for the relevant category (the input indicates RBI-prescribed upper limits where applicable).
- Only NBFCs meeting the recommended Minimum Investment Grade Credit (MIGC) or equivalent rating criteria may accept conditional deposits from the public, where such regulatory criteria are specified.
Regulatory exemptions and other regulators
Certain financial intermediaries are regulated by other sectoral regulators and are exempted from RBI registration to avoid dual regulation. These include (as per the input):
- Venture capital funds, merchant bankers and stock-broking companies regulated by the Securities and Exchange Board of India (SEBI).
- Insurance companies holding a valid certificate from the Insurance Regulatory and Development Authority (IRDAI).
- Nidhi companies (as notified under the Companies Act), which are regulated by the Ministry of Corporate Affairs.
- Companies conducting chit business as defined under the Chit Funds Act, regulated by the respective State Governments.
- Housing finance companies regulated by the National Housing Bank (NHB).
Bank finance to NBFCs
Banks may provide finance to NBFCs by way of direct loans, subscription to non-convertible debentures (NCDs), certificates of deposit or other modalities subject to supervisory guidance. For entities that do not require registration with the RBI (for example, certain insurance, Nidhi, chit-fund or SEBI-regulated entities), banks are expected to take credit decisions on the merits of the individual case considering the purpose of credit, nature and quality of underlying assets, borrower repayment capacity and risk assessment.
Where financing relates to activities considered sensitive or subject to regulatory restriction, banks must continue to observe policy restrictions notwithstanding operational freedoms in credit allocation.
Grievance redress: Ombudsman scheme
The RBI's Integrated Ombudsman Scheme (2021) extends to specified NBFCs. Under the scheme:
- The Ombudsman mechanism will cover services provided by a regulated entity in India to its customers, subject to specified exclusions.
- Certain NBFCs (as defined and not excluded under the scheme) fall within its scope; however, some NBFC categories such as Core Investment Companies (CICs), IDF-NBFCs, NBFC-IFCs, companies in resolution or liquidation, or other NBFCs specifically excluded by the RBI are not covered.
- The appellate authority under the scheme, for certain changes, has been designated at the level of an RBI Executive Director in place of the earlier arrangement.
Systemic safeguards and supervisory powers of the RBI
The RBI's supervisory toolkit for NBFCs includes:
- Power to require registration and to prescribe minimum NOF and other entry conditions.
- Prescription of prudential norms for capital adequacy, asset classification, provisioning, exposure limits and liquidity management.
- Power to require special audits, direct changes in accounting or disclosure practices, and issue supervisory directions to NBFCs and their auditors.
- Ability to initiate enforcement actions including prohibiting alienation of assets and filing winding-up petitions where warranted.
Common types of NBFCs (summary)
- Asset Finance Company (AFC)
- Loan Company (LC)
- Investment Company (IC)
- Core Investment Company (CIC)
- Infrastructure Finance Company (IFC)
- Microfinance Company / NBFC-MFI
- Housing Finance Company (often regulated by NHB)
- Mortgage Guarantee Company (MGC)
- NBFC-Peer-to-Peer (P2P) platforms
- NBFC-Account Aggregator (NBFC-AA)
- Infrastructure Debt Fund - NBFC (IDF-NBFC)
- Residuary NBFC (RNBFC)
Practical implications for customers and market participants
- Depositors should note that public deposits with NBFCs do not carry DICGC deposit insurance; therefore, counterparty credit risk must be considered.
- Borrowers and investors should check an NBFC's registration status, credit rating, public disclosures and compliance with regulatory reporting requirements.
- Banks financing NBFCs should carry out careful due diligence, particularly for NBFCs engaged in activities that may carry concentration risks or be sensitive from a systemic viewpoint.
Concluding summary
NBFCs are a diverse and significant part of the Indian financial system. They complement banks by serving specialised markets and underserved segments, enhancing financial inclusion and competition. Because of their financial-intermediary role and potential systemic impact, NBFCs are regulated by the RBI with specific prudential, reporting and consumer-protection measures. Understanding NBFC categories, registration requirements, prudential norms and the differences from banks is essential for customers, investors and financial-sector professionals.
