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Non-Banking Financial Company (NBFC)

  Mar 18, 2020

Non-Banking Financial Company (NBFC)

Role of NBFCs

How do the NBFCs contribute to the economy?

NBFCs, like banks, contribute in the following manner 

1. Enable converting saving into investments and thus helps in the mobilisation of funds/resources in the economy

2. Sustain consumption demand

3. Lend for capital formation

4. Unlike the regular banks, NBFCs extend long-term credits to infrastructure companies. The traditional banks expect short-term repayment of loans that may not always suit the requirements of large projects and so NBFCs lend

5. The financial market relies heavily on Non-banking financial institutions for raising capital. The start-ups and small-sized businesses are dependent on funds offered by NBFCs and also in order to maintain liquidity

6. NBFCs help attain the objective of macroeconomic policies of creating more jobs in the country by promoting

7. Raises the demand for manpower and creates employment

8. Micro finance Institutions, also known as MFIs offer financial services to low income populations.

What is Non-Banking Financial Company (NBFC)?

A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares / stocks / bonds / debentures / securities, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity etc. 

NBFCs are doing functions similar to banks. What is difference between banks & NBFCs?

NBFCs lend and make investments and hence their activities are akin to that of banks; however, there are a few differences as given below:

i. NBFC cannot accept demand deposits;

ii. NBFCs cannot issue cheques drawn on itself;

iii. Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.

Does the Reserve Bank regulate all financial companies?

No. Merchant Banking Companies, Stock Exchanges, Companies engaged in the business of stock-broking/sub-broking, Venture Capital Fund Companies, Nidhi Companies, Insurance companies and Chit Fund Companies are NBFCs but they have been exempted from the requirement of registration under Section 45-IA of the RBI Act, 1934 subject to certain conditions.

Merchant Banker/Venture Capital Fund Company/stock-exchanges/stock brokers/sub-brokers are regulated by Securities and Exchange Board of India, and Insurance companies are regulated by Insurance Regulatory and Development Authority. Similarly, Chit Fund Companies are regulated by the respective State Governments and Nidhi Companies are regulated by Ministry of Corporate Affairs, Government of India. Companies that do financial business but are regulated by other regulators are given specific exemption by the Reserve Bank from its regulatory requirements for avoiding duality of regulation.

Housing Finance Companies were regulated by National Housing Bank till 2018-19 but are presently under RBI regulation (Read ahead). 

What are the powers of the Reserve Bank with regard to 'Non-Bank Financial Companies’?

The Reserve Bank has been given the powers under the RBI Act 1934 to

1. Register,

2. Lay down policy,

3. Issue directions,

4. Inspect,

5. Regulate,

6. Supervise and

7. Exercise surveillance over NBFCs.

The Reserve Bank can penalize NBFCs for violating the provisions of the RBI Act or the directions or orders issued by RBI under RBI Act. The penal action can also result in RBI cancelling the Certificate of Registration issued to the NBFC, or prohibiting them from accepting deposits and alienating their assets or filing a winding up petition.

What is the NBFC crisis?

Non-banking financial companies (NBFCs) have been under stress since 2018. Gross non-performing assets (NPAs) of NBFCs as of 31 March 2019 stood at 6.60%. This is the worst in a period of six years. This means a greater proportion of loans given by NBFCs is not being repaid than in the past. 

How did they run into the crisis?

Like banks, NBFCs give out loans. Banks lend by taking deposits directly from the public. That’s not the case with most NBFCs. Only 88 of the 9,659 NBFCs take deposits. In order to give out loans, most NBFCs borrow from banks and sell commercial paper. The commercial paper they sell are basically short-term financial securities, which debt mutual funds buy. 

In the last two years, the share of bank borrowing as a proportion of total borrowings of NBFCs has gone up. This is where the problem lies.

NBFCs got access to easy money from banks. This, as is often the case, led to a small fall in lending standards and that has ultimately showed up in higher gross NPAs. The trouble at NBFCs such as Infrastructure Leasing and Financial Services Ltd, and Dewan Housing Finance Corp. Ltd forced banks and mutual funds away from NBFCs.

Also, they lent long to infra and other companies. This mismatch of assets and liabilities is the source of the crisis. 

What has the budget 2019-20 done to help the NBFCs?

In the budget 2019-20, the finance minister said fundamentally sound NBFCs should continue getting funds from banks for which the centre will provide a partial credit guarantee.

The FM proposed the government encourage public sector banks to buy high-rated pooled assets (securitized assets) of up to Rs 1 trillion of financially sound NBFCs, for which the government will provide partial guarantee.