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Blog
How Are NBFC's Better Than Banks?
Let’s know a bit about banks and NBFCs first
All the necessary aspects of society are served by financial institutions. Such institutions not only affect people, but also businesses and governments.
Banks and NBFCs are the most renowned financial institutions for every financial necessity but have you ever wondered how they differ or resemble one another?
A bank and a Non-Banking Financial Company (NBFC) are two distinctive financial institutions with very different approach in terms of – business models, operations, and regulatory requirements.
Where a bank is an authorized government financial institution, an NBFC is a company that performs similar banking operations but without a granted banking license.
On the one hand, Banks act as financial mediators between depositors and borrowers. They ensure the smooth functioning of the economy in the country.
On the other hand, NBFCs are regulated by the Reserve Bank of India under the RBI Act, 1934. For commencing the activities of an NBFCs, registration is mandatory.
Services Offered by NBFCs
- Loans and advances
- Saving and investment plans
- Credit facilities
- Insurance business
- Chit fund business
- Money transfer service, etc.
Services Offered by Banks
- Advancements of loans
- Discounting on bills of exchange
- Collecting and paying the credit instruments
- Guarantee by banks
- Credit & Debit cards
- Funds remittance, etc.
How are NBFCs better than banks?
The NBFC sector has significantly transformed over the past few years. Through leveraging technology in finance and particularly in the field of credit deployment, the NBFCs have outperformed banks in the mortgage sector.
They have carved a niche for themselves by understanding the customer needs, customizing the products for different customer segments, and expanding into underserved areas.
Gone are the days when one used to stand in lines for getting loans from banks. The easy accessibility and remote coverage has made NBFCs the most preferred option for borrowers as compared to banks. The major advantages of NBFCs over banks are as under:
1. Flexible eligibility criteria
In comparison to NBFCs, banks usually have stringent lending criteria for providing business loans. They follow a strict verification process and humungous documentation for approving business loan applications. However, NBFCs have a lenient and flexible eligibility criterion for approving business loan applications.
2. Competitive interest rates and charges
Compared to traditional banks, NBFCs offer business loans at a much lower interest rate. It means that there is reduced pressure on business owners when they avail a loan from an NBFC.
Additionally, loan processing fees and other charges levied by NBFCs are also a bit lower as compared to traditional banks.
3. Loan disbursal through a digital process
Most NBFCs have started offering 100% paperless business loans with the help of digital platforms and left very little space for physical documentation.
On the contrary, most banks still follow the traditional method, requiring the borrower to submit hard copies of the documents and be physically present at the branch for verification.
Why NBFCs are not banks?
NBFCs carry out various functions similar to banks, but they are not banks. Some of the significant differences between banks and NBFCs are enumerated below:
- Banks are government-authorized financial intermediaries that aim at providing banking services to the general people. Whereas NBFCs provide banking services to people without carrying a bank license.
- NBFCs are not allowed to accept deposits which are repayable on demand whereas banks can accept demand deposits.
- It is mandatory for banks to maintain reserve ratios like CRR or SLR. Whereas NBFCs are not required to maintain such reserve ratios.
Regulating authorities of NBFCs
The Department of Non-Banking Supervision (DNBS) has been entrusted with the responsibility of regulation and supervision of NBFCs under the regulatory – provisions contained under Chapter III B and C and Chapter V of the RBI Act, 1934.
Deposit-taking NBFCs and Systemically Important Non-Deposit Accepting Companies are subjected to a greater degree of regulation and supervision.
The focus of regulation and supervision is threefold, viz., a) depositor protection, b) consumer protection and c) financial stability.
RBI has been empowered to take punitive action which includes cancellation of Certificate of Registration, issue of prohibitory orders from accepting deposits, filing criminal cases, and winding up petitions under provisions of the Companies Act in extreme cases.
What do we think?
The difference between Banks and the NBFCs is huge – they differ in terms of the types of services they provide, mode of registration or incorporation, regulatory guidelines etc.
NBFCs have come to be regarded as important financial intermediaries, particularly for the small-scale and retail sectors with the growing importance assigned to financial inclusion.
Banking sector has always been highly regulated; however, simplified sanction procedures, flexibility and punctuality in meeting the credit needs and low-cost operations resulted in the NBFCs getting an edge over banks.
Are you a consultant who works on NBFC projects like obtaining NBFC License, Litigation related to suspended/cancelled licenses, or you work with Banks for show cause notices they receive, or their accounting or give opinion on their taxation dilemmas? Get Empaneled with us today for such project at https://masterbrains.co.in/professionals-empanelment/.
FAQs on How Are NBFC’s Better Than Banks?
What are the regulatory authorities governing NBFCs in India and other countries?
In India, the Reserve Bank of India (RBI) regulates NBFCs under the RBI Act 1934. Different regulatory authorities in other countries govern NBFCs, such as the UK’s Financial Conduct Authority (FCA) and the US Consumer Financial Protection Bureau (CFPB).
How are NBFCs able to operate without a banking license, and what are the restrictions on their operations?
NBFCs can operate without a banking license and hence they can not accept demand deposits and do not form part of the payment and settlement system. Being governed by the RBI under the RBI Act 1934, they are required to comply with the guidelines as specified under the said Act. These guidelines hereafter specify the restrictions on the operations of NBFCs such as on making investments or issuing cheques drawn on themselves or for public lending activities.
What are the various types of NBFCs?
Types of NBFCs include asset finance companies, investment companies, loan companies, microfinance institutions, and housing finance companies.
How do NBFCs compete with banks in the market ?
NBFCs compete with banks by offering specialized, customised and affordable services, targeting underserved segments, and providing flexible and convenient financial solutions to their target set of customers.
What are the factors that determine the interest rates offered by NBFCs, and how do they differ from those offered by banks?
Generally, the interest rates offered by the NBFCs are a tad bit higher than that of banks. Factors determining interest rates offered by NBFCs include the cost of funds, the risk profile of borrowers, the heavy competitive market, the regulatory framework, and market conditions. These factors may differ from banks, which often have access to cheaper sources of funds and stricter regulatory requirements.
How are NBFCs contributing to the overall development of the financial sector, and what are the future prospects of this industry?
NBFCs contribute to the overall development of the financial sector by complementing the services offered by banks despite being a healthy competition of the same, catering to niche markets by providing diversifying financial products, and promoting financial inclusion.
The future of NBFCs looks bright as this sector has somehow emerged as a game changer specifically for those sectors that were originally ignored by the traditional banks. The regulatory framework of these institutions has been working in the direction of making them more robust.
However, due to rampant non-compliance by existing NBFCs, RBI has tightened the knot and has been cancelling NBFC licenses on such non-compliances. In fact over the period the requirement of net owned funds has also been increased drastically to promote NBFCs with a better and safer base.
In fact, these days getting new NBFC licenses are being given by the RBI on very stringent and strict terms & conditions.
What are the various types of financial institutions in the Indian Market?
The Indian financial market comprises various types of financial institutions, including:
- Commercial Banks: These are the most common type of banks, offering a wide range of financial services such as accepting deposits, providing loans, and other banking services.
- Cooperative Banks: These banks cater to the financial needs of rural areas, primarily focusing on agriculture and related sectors.
- Regional Rural Banks (RRBs): Established to address the financial needs of rural and semi-urban areas, RRBs aim to develop the rural economy.
- Development Banks, also known as Industrial Financial Institutions, provide long-term financing to industries and infrastructure projects.
- Non-Banking Financial Companies (NBFCs): These companies offer financial services similar to banks but without a banking license. They include investment companies, loan companies, asset finance companies, and microfinance institutions.
- Insurance Companies: These companies provide various insurance products such as life, health, and general insurance to protect against financial losses.
- Housing Finance Companies (HFCs): These companies provide housing loans and related services to customers.
- Mutual Funds: These are investment vehicles that pool money from various investors to invest in different types of securities, such as stocks, bonds, and other assets.
- Stockbroking Firms: These firms facilitate buying and selling securities in the stock market on behalf of clients.
- Credit Rating Agencies: These agencies assess the creditworthiness of issuers of debt securities and provide ratings to help investors make informed decisions.
How can one register a new NBFC? At which authority it gets registered?
To register a new NBFC in India, one must follow these steps:
- Incorporate a Company: The first step is to incorporate a company under the Companies Act 2013 with the Registrar of Companies (ROC). The main objective of the company should be to carry out financial activities.
- Minimum Net Owned Funds: Ensure that the company has a minimum net owned fund (NOF) of INR 2 crore or as specified by the Reserve Bank of India (RBI) for different NBFCs.
- Obtain Necessary Documents: Prepare all the necessary documents, including the Certificate of Incorporation, Memorandum and Articles of Association, address proof of the registered office, and documents related to directors and shareholders.
- Apply for an NBFC License: Submit an online application for an NBFC license to the Reserve Bank of India (RBI) through the COSMOS (Company System for Monitoring of NBFCs) portal along with the required documents.
- RBI Scrutiny: The RBI will scrutinize the application and may ask for additional information or clarifications. Ensure that you provide all the necessary information promptly.
- Grant of License: If the RBI is satisfied with the application, it will grant a Certificate of Registration (CoR) under Section 45-IA of the RBI Act, 1934, allowing the company to commence its NBFC operations.
The registration of an NBFC is done with the Reserve Bank of India (RBI), the primary regulatory authority for NBFCs in India.
How do NBFCs contribute to financial inclusion in India?
NBFCs contribute to financial inclusion in India by providing financial services to unbanked and underbanked populations, offering customized financial products for niche markets, and utilizing innovative technology to reach remote and rural areas. Their flexible lending criteria and customer-centric approach make them accessible to small businesses, low-income households, and individuals with limited access to formal banking channels.
What is the role of technology in the growth and operations of NBFCs?
Technology plays a crucial role in the growth and operations of NBFCs. It enables them to offer innovative financial products and services, streamline processes, reduce operational costs, and enhance customer experience. By leveraging technology, NBFCs can offer digital lending platforms, mobile banking, and online account management, making it easier for customers to access their services anytime, anywhere.
Are NBFCs allowed to provide foreign currency loans in India?
Yes, certain types of NBFCs, known as Infrastructure Finance Companies (IFCs), Infrastructure Debt Fund NBFCs (IDF-NBFCs), and Export-Import Bank of India (EXIM Bank) are allowed to provide foreign currency loans in India, subject to the guidelines and regulations set by the Reserve Bank of India (RBI).
What is the difference between a deposit-taking NBFC and a non-deposit-taking NBFC?
A deposit-taking NBFC is an NBFC that is allowed to accept public deposits, subject to RBI regulations and guidelines. These NBFCs have a higher degree of regulation and supervision to ensure the safety of depositors’ funds. A non-deposit-taking NBFC, on the other hand, does not accept public deposits and relies on other sources of funds, such as wholesale funding or borrowings, to finance their operations.
How do NBFCs manage the risks associated with their lending activities?
NBFCs manage the risks associated with their lending activities by implementing robust credit risk assessment and management practices, including comprehensive borrower evaluation, diversification of loan portfolios, regular monitoring of loan performance, and effective recovery mechanisms. They also maintain adequate capital buffers to absorb potential losses and comply with RBI’s prudential norms to ensure the stability and resilience of their operations.
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