What is an NBFC?

An NBFC (Non-Banking Financial Company) is a financial institution that provides financial services similar to banks but does not hold a banking license.

NBFCs play an important role in the economy by providing credit and other financial services to parties usually not served by traditional banks.

The concept of an NBFC emerged in the early 1960s when the financial needs of the population were not being met by traditional banks.

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Functions of an NBFC

NBFCs promote economic growth in the country by catering to sections of the society not served by traditional banks. These may be high-risk industries or individuals like low-income farmers or MSMEs.

Here is a list of the functions of an NBFC:

  • Retail Financing to individuals, households and businesses who may not qualify for traditional bank loans.

  • Infrastructure financing for projects essential for economic growth and development, such as roads, bridges, power plants, and telecommunication networks.

  • Hire Purchase Services to help individuals and businesses acquire assets such as vehicles, machinery, and equipment without upfront payment.

  • Trade Finance solutions to businesses, facilitating domestic and international trade transactions like letters of credit, factoring, and bill discounting.

  • Asset Management services enable individuals and institutions to invest in various asset classes such as equities, debt, and real estate.

  • Providing venture capital funding to early-stage and high-growth potential businesses.

  • NBFC-MFIs (Microfinance Institutions) provide microloans and other financial services to low-income individuals and small businesses in rural and unbanked areas.

  • Investment Banking Services to assist businesses in raising capital and executing strategic transactions.

  • Facilitating payments and remittances, enabling individuals and businesses to transfer funds seamlessly.

  • Insurance services provide individuals and businesses with risk protection and financial security against various contingencies.

Types of NBFCs

The categorization of NBFCs is constantly changing based on RBI regulations.

The RBI categorizes NBFCs in terms of whether they take deposits or not, the activity they conduct, and their systemic importance.

Asset Finance Company (AFC)

An asset finance company helps individuals and businesses finance the purchase of physical assets like automobiles, tractors or other equipment that support economic or productive activity.

To be classified as an AFC, at least 60% of the NBFC’s business has to come from this kind of lending.

Investment Company (IC)

An investment company is an NBFC that makes money from acquiring securities in the form of equity shares, debt instruments or government securities.

NBFC ICs help both corporate and individual investors invest their money in the best and most productive way.

Loan Company (LC)

Any NBFC providing loans but not fulfilling the AFC requirement is categorized as a Loan Company.

Infrastructure Finance Company (IFC)

An NBFC-IFC finances the country’s infrastructural development. They finance sectors like power, roads, telecom and transport. These NBFCs are crucial for economic development and progress.

Here are the criteria required for an NBFC to be categorized as an NBFC-IFC:

  • At least 75% of the NBFC’s total assets have to be invested in infrastructure loans
  • Minimum of Rs 300 crore in net owned funds
  • Minimum credit rating of ‘A’ or equivalent
  • Credit risk adequacy ratio (CRAR) of 15%
Systemically Important Core Investment Company (CIC-ND-SI)

CIC-ND-SI engages in acquiring shares and securities.

They are different from NBFC-IC because CIC-ND-SI invests at least 90% of its total assets in its own group companies, and 60% of its total assets must be invested in equity shares of its group companies.

Other conditions that an NBFC must meet to be classified as a CIC-ND-SI:

  • It does not actively trade its investments in shares, debt, or loans in group companies, except through block sales for dilution or disinvestment purposes.
  • It should not engage in financial activities specified in Section 45I(c) and 45I(f) of the RBI Act, 1934, except for activities like investing 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
  • The company must have an asset size of ₹100 crores or more
  • It must accept public funds
Infrastructure Debt Fund

An Infrastructure Debt Fund Non-Banking Financial Company (IDF-NBFC) channels long-term debt into infrastructure projects.

It raises funds primarily by issuing rupee or dollar-denominated bonds of at least 5 years of maturity, and can only be sponsored by an NBFC-IFC (Infrastructure Finance Company).

Non-Banking Financial Company Micro-Finance Institution (NBFC-MFI)

These are non-deposit-taking NBFCs that disburse at least 85% of their total loans according to the following criteria:

  • Loan to rural households with annual income of less than Rs 1,00,000, or urban/semi-urban households with income of less than Rs 1,60,000
  • Loan less than Rs 50,000 in first cycle and Rs 1,00,000 in subsequent cycles
  • Total loan less than Rs 1,00,000
  • Tenure of the loan less than 2 years
  • For loans of ₹15,000 or more, the loan repayment period must be at least 24 months; prepayment is allowed without penalty

  • Loans extended without collateral
  • Loans given for income generation make up at least 50% of the total loans given by the NBFC
  • Loans are repayable on weekly, fortnightly or monthly instalments
Non-Banking Financial Company Factors (NBFC-Factors)

These are another kind of non-deposit-taking NBFC which provides factoring services.

The NBFC should derive at least 50% of its total income from factoring services, and the factoring business should constitute at least 50% of its total assets.

Mortgage Guarantee Companies (MGC)

At least 90% of the business turnover or gross income has to be from the mortgage guarantee business; the net owned fund of this NBFC also has to be at least Rs 100 crore.

NBFC Non-Operative Financial Holding (NBFC-NOFHC) Company

An NBFC-Non-Operative Financial Holding Company (NOFHC) serves as a financial entity allowing promoters or promoter groups to establish a new bank.

Residuary Non-Banking Company (RNBC)

Any NBFC that holds deposits but cannot be classified as an AFC, LC or IC is classified as an RNBC.

These companies function differently from NBFCs in terms of deposit mobilization and requirement of depositor fund deployment.

The RBI has guidelines and regulations for these companies as well.

Net Owned Fund

The NOF is the difference between an NBFC’s paid-up capital, free reserves, and other surplus funds, and its intangible assets, accumulated losses, and deferred revenue expenditure.

The Net Owned Fund is like an NBFC’s “net worth”: what it owns, minus what it owes.

It represents the financial strength and stability of an NBFC, indicating its capacity to absorb losses and fulfil its financial obligations.

What Impacts the NOF?

  • Profits and losses directly affect the NOF. Consistent profitability increases the NOF, while losses can erode it.
  • NBFCs can also strengthen their NOF by raising additional capital through issuing shares or bonds.
  • Conversely, high expenses, write-offs of bad loans, and distributions to shareholders can decrease the NOF.

How to Calculate NOF?

  1. Gather the relevant financial data for the NBFC, such as the balance sheet and income statement.
  2. Identify the values for each component mentioned above based on the financial reports.
  3. Substitute the values into the formula:

NOF = Paid-up Capital + Free Reserves + Other Surplus Funds – Intangible Assets – Accumulated Losses – Deferred Revenue Expenditure

Component Description Formula Source
Paid-up Capital (PUC) Total amount raised through issuing shares Balance Sheet
Free Reserves (FR) Accumulated profits not distributed to shareholders Balance Sheet
Other Surplus Funds (OSF) Share premium, retained earnings from subsidiaries, contingency reserves Balance Sheet/Notes
Intangible Assets (IA) Brand value, intellectual property, goodwill Balance Sheet
Accumulated Losses (AL) Total losses incurred over time Balance Sheet
Deferred Revenue Expenditure (DRE) Expenses incurred in advance for future benefits Balance Sheet/Notes
Net Owned Fund (NOF) Financial strength & stability indicator PUC + FR + OSF – IA – AL – DRE

RBI Guidelines for NBFCs

The RBI has issued a number of circulars and policies to regulate NBFCs and protect the interests of depositors and investors.

Prudential Guidelines

  • Minimum Net Owned Funds (NOF): NBFCs require a minimum NOF to maintain a buffer against losses and absorb financial shocks. The minimum amount varies based on the type of NBFC and its activities.
  • Capital Adequacy Ratio (CAR): Similar to banks, NBFCs must maintain a minimum CAR, which is the ratio of their capital to their risk-weighted assets. This ensures they have sufficient capital to cover potential losses.
  • Liquidity Requirements: NBFCs need to maintain a minimum level of liquid assets, such as cash and government securities, to meet their short-term liabilities. This helps them avoid liquidity crunches.
  • Income Recognition and Asset Classification: RBI prescribes income recognition and asset classification norms to ensure accurate financial reporting and timely recognition of bad loans.
  • Concentration Limits: NBFCs cannot have excessive exposure to a single borrower or group of borrowers to avoid concentration risk.

Process of Getting an NBFC License in India

According to the RBI, any company where income from financial assets makes up more than 50% of its gross income and financial assets constitute more than 50% of its total assets, can be called an NBFC.

Once the applicant company feels they fulfil this criteria, they can apply for an NBFC license online.

The applicant will have to provide certain documents and fill out forms.

The RBI will then assess the “fit and proper” status of the NBFC’s promoters and senior management to ensure integrity and whether they fit the criteria of selection.

Other records, like the company’s CIBIL record, are also assessed.

Here are the other criteria that a company must fulfil in order to get an NBFC license:

  • The company must be registered as a public or private company
  • Must have at least Rs 10 crores are minimum NOF
  • One-third of all directors must have finance-related work experience
  • Fulfilment of regulations and norms under Capital compliances and FEMA laws.

Once all these checks are completed, the RBI issues an application reference number (ARN), which can be used to check the status of the application.

If satisfied, the RBI will then issue an NBFC license to the company. The NBFC must then submit regular financial and prudential reports to the RBI for monitoring and supervision.

NBFCs vs Banks

Feature Bank NBFC
License Banking license from RBI Non-banking license from RBI
Deposits Accepts demand deposits (savings, current) Limited deposit acceptance (bonds, debentures)
Focus Broad range of services (retail, corporate, investment) Niche areas (microfinance, infrastructure, equipment leasing, gold loans, etc.)
Regulations Stricter (capital adequacy, liquidity, lending practices) More flexible, but still regulated (based on activity and size)
Strengths One-stop shop for financial needs, deposit security Specialized expertise, faster approvals, competitive rates in specific areas
Weaknesses Less flexibility, may not specialize in your needs More limited deposit options, higher risk profile in some areas
Suitable for Individuals, businesses with diverse financial needs Individuals, and businesses seeking focused solutions in specific areas

 

NBFCs and Banks

A salient feature of NBFCs is their inherent flexibility in working with other businesses like fintechs or banks.

Many fintechs are getting NBFC licenses or partnering with existing NBFCs to provide an extended range of services to the public.

The best example of NBFCs and Banks working together for the benefit of society is in a co-lending partnership.

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