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All About Non Banking Financial Company (NBFC)

  • Bhumika Dutta
  • May 20, 2022
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The banking sector controls the majority of the Indian financial system. Non Banking Financial Companies (NBFCs) or Non Banking Financial Institutions (NBFIs) play a significant role in providing complementarity and competitiveness to banks. A business registered under the Companies Act 2013 or 1956 is referred to as a non-banking financial institution.

 

A Non Banking Financial Company is a financial institution that provides loans and advances, purchases shares, stocks, bonds, debentures, or other securities issued by the government or a local authority, leases, hire-purchase, insurance, or chits, but does not include any institution whose primary business is agriculture, industrial activity, the purchase or sale of any goods (other than securities), or providing any services.

 

In this article, we are going to learn about the definition and types of these NBFCs.


 

What is a Non Banking Financial Company (NBFC)?

 

A non banking financial company is a corporation whose primary activity is to receive deposits under any plan or arrangement through any channel.

 

To provide clarity to the businesses that would be monitored and regulated as NBFCs under the RBI statute, the Reserve Bank of India defined "financial activity" as "primary business." The 50-50 act is the name of this criteria

 

To meet the 50-50 requirement, the company's financial assets must account for half of its overall assets. In addition, financial asset income must account for half of the overall income. It is supervised by both the Ministry of Corporate Affairs and the Reserve Bank of India. The RBI issues a license for operation, and it is established as a corporation under the laws of the nation.

 

Because banks are unable to meet all of India's financial business demands, non banking financial companies (NBFCs) play a critical role in the country's financial industry. As a result, the Indian economy has been declining in recent years due to the failure of financial institutions in the country. Investment banks, mortgage lenders, money market funds, insurance firms, hedge funds, private equity funds, and peer-to-peer lenders are examples of NBFCs.

 

NBFCs are sometimes referred to as "shadow banks" since they operate similarly to banks but with fewer regulatory constraints. Except for a handful, they are unable to accept deposits from individuals and must instead rely on bonds or bank borrowing.


 

Types of Non Banking Financial Companies:

 

Non banking financial companies come in a variety of shapes and sizes. NBFCs are divided into Deposit and Non-Deposit Accepting NBFCs, systemically important and other non-deposit holding businesses, and by the sort of activity they engage in. Here are the types of NBFCs:

 

  1. Asset Finance Company (AFC):

 

An AFC is a financial organization that focuses on the financing of physical assets that support productive/economic activity, such as automobiles, tractors, lathe machines, generator sets, earthmoving and material handling equipment, self-propelled vehicles, and general-purpose industrial machinery. The aggregate of financing real/physical assets supporting economic activity and the income deriving therefrom is not less than 60% of total assets and income for this purpose.


 

  1. Investment Company (IC):

 

Any corporation that is a financial institution and whose primary activity is the acquisition of securities is referred to as an IC.


 

  1. Loan Company (LC):

 

Any firm that is a financial institution that provides financing as its primary business, whether through loans, advances, or other means, for any activity other than its own, but does not include an Asset Finance Company is called LC.


 

  1. Infrastructure Finance Company (IFC):

 

IFC is a non-banking financing firm that:

a) invests at least 75% of its total assets in infrastructure loans, 

b) has a minimum Net Owned Funds of $300 million, 

c) has a credit rating of "A" or equivalent, and 

d) has a CRAR of 15%.


 

  1. Infrastructure Debt Fund (IDF):

 

IDF-NBFC is a corporation that has been registered as a non-bank financial institution (NBFI) to facilitate the flow of long-term loans into infrastructure projects. IDF-NBFC raises funds by issuing rupee or dollar-denominated bonds with a minimum term of five years. IDF-NBFCs can only be sponsored by Infrastructure Finance Companies (IFC).

 

 

  1. Micro Finance Institution (MFI):

 

NBFC-MFI is a non-deposit-taking NBFC with at least 85% of its assets in the form of qualifying assets that meet the following requirements:

 

  • An NBFC-MFI loan to a borrower having a rural household yearly income of not more than 1,00,000 or an urban and semi-urban family income of not more than 1,60,000;

  • In the first cycle, the loan amount is limited to $50,000, and in the following cycles, the loan amount is limited to $1,000,000;

  • The borrower's total debt does not exceed $1,000,000;

  • For loans over $15,000, the loan term must be at least 24 months, with no penalty for early repayment.

  • a loan that will be issued without the need for collateral;


 

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

 

CIC-ND-SI is an NBFC that engages in the acquisition of shares and securities and meets the following criteria:

 

  • It invests at least 90% of its Total Assets in group firms as stock, preference shares, debt, or loans;

  • No less than 60% of its Total Assets are invested in equity shares (including instruments compulsorily convertible into equity shares within a period not exceeding 10 years from the date of issuance) in group firms.

  • It does not trade in its interests in group businesses' shares, debt, or loans, except through block sales for dilution or disinvestment;

  • It takes public funding and has an asset size of at least 100 crores.

  • Except for investments in bank deposits, money market instruments, government securities, loans to and investments in debt issuances of group companies, or guarantees issued on behalf of group companies, it does not engage in any other financial activity as defined in Section 45I(c) and 45I(f) of the RBI Act, 1934.


 

Also Read | Introduction to Mobile Banking

 

  1. Non-Operative Financial Holding Company (NOFHC):

 

It is a financial entity that will allow promoters/promoter groups to establish a new bank. It's a wholly-owned Non-Operative Financial Holding Company (NOFHC) that will hold the bank, as well as all other financial services firms regulated by the RBI or other financial sector authorities, to the degree permitted by relevant regulatory prescriptions. 

 

It is required for any firm planning to establish the above-mentioned business to register with the Reserve Bank of India and get a Certificate of Registration. For failing to comply, the Reserve Bank can levy a penalty or fee, or even prosecute them in a court of law.


 

  1. NBC Factors:

 

NBFC-Factor is a non-deposit accepting non-banking financial institution that specializes in factoring. Financial assets in the factoring business should account for at least 50% of total assets, and factoring company income should not account for less than 50% of total revenue.


 

The process of incorporating an NBFC:

 

An NBFC must satisfy the following standards to be formed:

 

  • A company must first be incorporated under the Companies Act 2013 or must already be registered as a private limited or public limited company under the Companies Act 1956.

 

  • The company's net-owned funds should be at least 2 crore INR.

 

  • 1/3 of the board of directors must have financial experience.

 

  • The company's CIBIL records should be spotless.

 

  • A thorough five-year business plan is required of the company.

 

  • FEMA and capital compliance criteria must be met by the firm.

 

  • After all of the aforementioned prerequisites have been met, an online application should be filled out and submitted together with the required papers on the RBI website.

 

  • After that, a CARN number will be produced.

 

  • A paper copy of the application must also be delivered to the Reserve Bank of India's regional branch.

 

  • The license will be awarded to the firm when the application has been thoroughly evaluated.


 

Financial Organizations that do not need an NBFC license:

 

Certain entities that engage in financial activity do not need to register with the Reserve Bank of India (RBI). These companies do not require NBFC registration or RBI NBFC requirements since they are governed by other financial sector authorities. The following are the entities:

 

  • The Insurance Regulatory and Development Authority of India regulates insurance companies (IRDA)

 

  • The National Housing Bank regulates the housing finance companies.

 

  • The Securities and Exchange Board of India regulated stock brokerage firms.

 

  • The Securities and Exchange Board of India regulated merchant banking companies.

 

  • The Securities and Exchange Board of India regulated mutual funds.

 

  • The Securities and Exchange Board of India regulated venture capital firms.

 

  • Companies that manage Securities and Exchange Board of India-regulated Collective Investment Schemes

 

  • Companies that manage chit funds are regulated by their respective state governments.

 

  • The Ministry of Corporate Affairs regulates Nidhi Corporations (MCA)



 

NBFC Controversy:

 

NBFC proponents claim that these financial organizations are critical in addressing the increased demand for credit, loans, and other financial services. Customers include both enterprises and people, particularly those who may struggle to qualify under a typical bank's more severe criteria.

 

Proponents argue that NBFCs not only provide alternative lending sources, but also more efficient ones. In a practice known as disintermediation, NBFCs take out the middleman—often banks—to allow clients to deal directly with them, decreasing expenses, fees, and rates. It is critical to provide finance and credit to keep the money supply liquid and the economy running smoothly.

 

Advantages of NBFC:

 

  • Alternative finance and credit sources

  • Clients are contacted directly, reducing the need for intermediaries.

  • Investors can expect high returns.

  • The financial system's liquidity


 

Disadvantages of NBFC:

 

  • There are no regulations in place, and there is no control.

  • Operations that aren't transparent

  • The financial sector and the economy are both in danger of systemic risk.

 

Despite this, opponents are concerned about NBFCs' lack of regulatory responsibility and their ability to operate outside of traditional banking laws and regulations. If they're public corporations, they'll be regulated by the Securities and Exchange Commission (SEC), and if they're brokerages, they'll be regulated by the Financial Industry Regulatory Authority (FINRA). In some circumstances, though, they may be able to operate with less openness.

 

Also Read | 8 Different Types of Loans


 

Guidelines that NBFCs need to follow:

 

The Reserve Bank of India supervises the functions of NBFCs in India (RBI). As a result, NBFCs must follow the RBI's rules set out in Chapter III B of the RBI Act of 1934. The RBI has enacted the following regulations:

 

  • NBFCs are not permitted by law to receive demand deposits from public depositors or investors.

  • The firm is allowed to collect public deposits for a minimum of 12 months and a maximum of 60 months.

  • The Reserve Bank of India will not guarantee that any money borrowed by NBFCs would be repaid.

  • The Company cannot charge an interest rate higher than the Reserve Bank of India's permitted rate.

  • Customers can get checks from NBFCs to make payments or settlements.

  • Every year, the corporation must submit a record of the statutory return on the deposits it has accepted in the form NBS-1.

  • The corporation is required to provide a quarterly return on its liquid assets.

  • Every year, the company's audited balance sheet must be provided.

  • Every six months, the firm must determine its credit ratings and report them to the RBI.

  • Companies with a Public Deposit of Rs.20 crore or assets of Rs.100 crore would be required to file an ALM return every six months.

  • NBFC depositors are not eligible for the Deposit Insurance and Credit Guarantee Corporation's securing facility (DICGC).

  • Only NBFCs with a rating that meets the required Minimum Investment Grade Credit (MIGC) rating are permitted to take conditional deposits from public depositors.

  • The RBI has prohibited NBFCs from giving clients or depositors additional advantages, incentives, or gifts beyond those provided by banks.

  • In its Liquid Assets, the corporation must keep a minimum of 15% of its Public Deposits.


 

Conclusion:

 

Nonbank financial firms (NBFCs), sometimes known as nonbank financial institutions (NBFIs), are businesses that offer services comparable to those offered by banks but do not have a banking license. 

 

As a result, they are not regulated or supervised by federal or state governments. There are a lot of NBFCs, NBFCs include investment banks, mortgage lenders, money market funds, insurance firms, hedge funds, private equity funds, and peer-to-peer lenders. These NBFCs have been mentioned in this article.

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