Non-Banking Financial Corporation (NBFCs)

About

• The NBFCs are companies incorporated through the Companies Act, 1956, which are involved in financial operations like;
  • • Offering loans and advances,
    • Purchasing of shares, stocks, bonds, debentures, or other marketable securities,
    • Running deposit plans in different forms.
• It excludes any institution whose key business is that of agricultural activity, industrial activity, buying or selling any goods (not securities), or offering any services and the sale/purchase/construction of immovable property. 
• NBFCs have their functions controlled by the Ministry of Corporate Affairs and Reserve Bank of India.

What is the distinction between banks and NBFCs?

• The lending activities of NBFCS, as well as their investments are similar to those of banks; though there are a few differences as explained below:
• Demand Deposits: NBFC is not allowed to take demand deposits;
• Payment System: NBFCs are not a part of the payment and settlement system and are unable to issue a cheque that is drawn on itself;
• Deposit Insurance: Depositors of NBFCs do not have access to the deposit insurance facility of the Deposit Insurance and Credit Guarantee Corporation as is the case with banks.

Importance of NBFCs

• The NBFCs form an important part of the financial ecosystem of India, especially in rural and semi-urban regions where banks have low coverage. Their importance lies in;
  • • Financial Inclusion: building credit in underserved areas.
    • More Rapid Services: Simplified processes and doorstep services.
    • Priority Sector Lending (PSL): Meeting credit requirements in agriculture, microfinance and other unorganized sectors.
    • Economic Growth: The sectors that will be supported with the help of financing are housing, infrastructure, and small businesses.

Challenges faced by NBFCs

• Increased Risk Weights: In 2023, the RBI raised risk weights of loans to NBFCs, which made borrowing by banks costlier.
  • • By April 2024, bank funding to NBFCs had reduced year-on-year by 22 to 15 percent.
• Funding Constraints: NBFCs with lower credit ratings have a fund crunch that is attributable to the increasing cost of borrowing and the availability of finances.
• Shallow Bond Market: Indian debt market is not very deep and liquid, such that it is accessible to diversified internal financing.
• Regulatory Limits: The restrictions that SEBI imposes on issuing International Securities Identification Number (ISIN) and the lack of market makers actively involved in the bond markets are the limiting factors to the development of the bond markets.
• Cost Pressures: NBFCs are impacted by cost pressures, which are expected to rise to a range of 2.6 percent in 2024 and to 4 percent in 2025.
• Foreign Borrowing Problems: Although it is very enticing as it is less expensive to hedge, overseas funding is still in its infancy among most NBFCs.

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