Common Differences Between Banks and NBFCs

Globalisation is on a steep rise, and businesses tend to turn complex, given this rise. To provide adequate support for these complexities, financial institutions have geared up to offer a range of financial products and services. Such financial institutions provide a strong foothold for businesses all around the world, especially so during the time of market fluctuations. They appreciate these financial institutions for the economic prosperity they bring in.

Recently, we have also seen a rise in the number of financial institutions. This has led to intense competition among financial institutions. Thus, financial institutions offer a variety of products to banking as well as non-banking customers at highly competitive prices. This puts investors and borrowers who are looking for economic opportunities in tight spots where it becomes challenging to make a choice.

Every right-minded consumer compares products by looking at the features it offers before choosing one. Even product reviews help in assessing the reliability of a particular product. Sometimes, the reputation of an institution or brand guides the decision-making process. Consumers are ready to pay a relatively higher price for their product if an institution offers it with a good market standing.

Thus, in the case of financial institutions, customers are left to assess whether he or she wants a financial or non-financial institution. They are also required to access the reputation of the institution and the services it offers.

While banks have been the most renowned financial institutions around the world. Recently, non-banking financial companies (NBFCs) have become popular when it comes to carrying out lending and other financial activities.

NBFCs and Banks Resemble Each Other in Many Ways but Have Considerable Differences as Well

NBFCs

The non-banking financial companies or NBFCs come registered under the Companies Act of 1956. They were formed by the GOI, with the motive of offering banking services to the under-privileged individuals who are reluctant about the gamut of banks and their services.

To be an NBFC, a financial company needs to fulfill two criteria: 

1. Its financial assets should make up more than 50 percent of the total assets
2. The income from those assets must make up more than 50 percent of its gross income.

NBFC provides lending services similar to banks. Their services range from offering advances, savings, and investment products along with managing stock portfolios, credit facilities, money market tradings, money transfers, etc. Further, NBFCs are also participating in activities like housing finance, hire purchase, venture capital, leasing, and infrastructure finance.

However, NBFCs only accept term deposits and never entertain deposits that are repayable on demand.

NBFC institutions can be of six types: 

1. NBFC that is an investment company involved in the acquisition of securities,
2. NBFC that is a loan disbursal company
3. NBFC that is an excluding asset finance company
4. NBFC that functions as an infrastructure finance company with at least 75 percent of its assets in infrastructure loans
5. NBFC that is a systemically important core investment company
6. NBFC is an infrastructure debt fund.

Even the RBI has issued rules and regulations to ensure that the NBFCs function smoothly. Regulation surrounds functions like accepting deposits, such as a compulsory credit rating, mandatory management of liquid assets for repayment, exposure limitation, depositing books, adequate capital maintenance, and the inspection of the NBFCs.

Bank

Banks are financial institutions that fall under the authority of a government. They execute banking activities such as granting loans, accepting deposits, managing withdrawals, providing utility services, and clearing checks too. Banks almost control a country’s financial system. The role of a bank as a financial intermediary, between depositors and borrowers, makes it possible for economies to function with ease. The responsibilities of banks include creating credit products, lending loans, managing deposits, securing money transfers, and providing public utility services.

There are different types of banks:

1. Public sector banks
2. Foreign banks
3. Private sector banks

Banks can also be categorized into segments like central banks and commercial banks. While every country has only one central bank, there is no limit to the number of commercial banks a country can have. Shareholders generally own banks. They are profit-driven institutions that function intending to increase shareholders’ wealth.

Common Differences between Banks and NBFCs

1. Origination

While NBFCs were formed under the Companies Act of 1956, banks were registered under the Banking Regulation Act of 1949. Both banks and NBFCs follow different sets of rules and regulations for the provision of services.

2. Authorisation

Banks and NBFCs differ in terms of the level of their authorisation. NBFCs do not require to hold a bank license to offer banking services to the public. However, the banks are authorized by governments, and they function with the ultimate goal of serving the general public.

3. Demand Deposits

A demand deposit is a fund from which a borrower can withdraw a deposit at any time, from the financial institution. While NBFCs do not accept DDs for any financial transactions, banks do accept them. Customers of banks use DD accounts for making payments.

4. Maintenance of Reserve Ratio

The Reserve ratio is the term used to describe a part of the depositor’s balance that must be kept by a bank as cash, as dictated by the central bank. NBFCs are under no regulation to maintain a reserve ratio to function in the economy; however, banks must maintain a reserve ratio as it affects the supply of money in a country.

5. Foreign Investment

While NBFCs are allowed to make a financial investment of up to 100 percent of their assets, banks can only make a limited financial foreign investment. As per the regulations, only Private Sector banks are allowed to accept FDI, and that too only up to 74%.

6. Deposit Insurance Facility

The facility of deposit insurance is offered by the Deposit Insurance and Credit Guarantee Corporation. While the deposit insurance facility is not available for NBFCs, banks can enjoy its perks and use it to safeguard their clients’ money.

In The End

Most customers resort to banks when they need more significant amounts and lower interest rates. However, today even NBFCs are providing their customers with competitive interest rates and great offers on loan products. This is the main reason why NBFCs have seen exponential growth in the past few years, both in terms of the demand they receive and the services they offer.

Without any stringent requirements for collaterals, thanks to their alternate credit disbursement mechanisms and the help of AI and ML, NBFCs often offer streamlined loan disbursal, even for borrowers with no credit history. This is the reason why they are gaining more popularity as compared to traditional banks.

Finezza is a lending management software that helps NBFCs to what they do, just efficiently. If there is anything else, you would like to know about NBFCs, their functions, or their facilities, write to us in the comment section below.