Full Form of NBFC – Non-Banking Financial Companies
The full form of NBFC is Non-Banking Financial Companies. NBFC refers to non-banking financial companies responsible for offering various services similar to that of the banking companies, like providing loans/advances to businesses and others, hire-purchase, leasing, and acquisition of various securities issued by the government or local authorities or any other marketable securities of similar nature.
One of the key distinguishing factors of NBFC companies is their focus on niche markets or underserved segments of the population. Unlike banks, which typically cater to a broader customer base, NBFCs often specialize in specific sectors or customer segments, such as small and medium-sized enterprises (SMEs), consumer finance, housing finance, microfinance, or infrastructure financing.
Table of contents
An NBFC is a non-banking financial company that does not hold a banking license but works like a bank as it provides all of the services similar to the services provided by the banks. Although these companies do not have a banking license, they are required to follow banking regulations. An interesting characteristic of NBFC loans is their reliance on market-based funding sources rather than traditional deposits. While banks primarily rely on customer deposits to fund their lending activities, NBFCs raise capital through sources such as commercial paper, bonds, debentures, and term loans from financial institutions. This diverse funding mix enables NBFCs to access capital markets more easily and quickly adapt to changing market conditions or regulatory requirements.
NBFCs play a vital role in promoting financial inclusion and economic growth by extending credit to individuals and businesses that may have limited access to traditional banking services. They complement the efforts of banks and other financial institutions in serving the diverse financing needs of the economy, contributing to increased access to finance, job creation, and entrepreneurship.
However, NBFCs also face unique challenges, including regulatory compliance, liquidity management, credit risk management, and asset-liability mismatches. As such, effective regulation and supervision are essential to ensure the stability and resilience of the NBFC sector while promoting innovation and financial inclusion. Understanding the role and dynamics of NBFCs is crucial for policymakers, investors, and consumers alike in understanding the evolving nature of the financial world and contributing to sustainable economic development.
Let us understand the role of a NBFC company through the explanation below.
- NBFC plays a significant role in building the nation and financial inclusion as it provides funds/Loans to those sections of the unbanked society, especially small enterprises.
- It is a major source of funding for new start-ups and entrepreneurs, especially where the government focuses on promoting entrepreneurship so one can replace those job seekers with job creators.
- They play a pivotal role in infrastructure development, employment generation, transport development, creation of wealth opportunities, financial support to the financially vulnerable sections of society, etc.
Officially, non-banking financial companies classify under the Dodd-Frank Wall Street Reform and Consumer Protection Act 2010, which is the financial reform legislation passed in 2010 in response to the financial crisis that occurred in 2008. As per the act, NBFC loans come from companies that predominantly engage in financial activities in case their more than 85% consolidated assets or annual gross revenues are financial. Therefore, a wide range of companies came into this category, which offers services like that of the banks like Mortgage lending companies, insurance companies, private equity funds, Investment banksInvestment BanksInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc., money market fundsMoney Market FundsA money market fund is a form of short-term debt security or open-ended mutual fund with a shorter maturity, offering good returns at high liquidity and low credit risk. The instruments it invests in include US Treasury bills, bank debt funds, and corporate commercial papers that could be taxable or free from tax., hedge fundsHedge FundsA hedge fund is an aggressively invested portfolio made through pooling of various investors and institutional investor’s fund. It supports various assets providing high returns in exchange for higher risk through multiple risk management and hedging techniques., peer-to-peer lenders, etc.
The various objectives of non-banking financial companies or NBFC companies are:
- The NBFCs aim to create more job opportunities in the country by lending loans to private industries and SMEs, increasing business, raising the workforce’s demand, and creating employment.
- They also help mobilize funds by the rotation of resources, distribution of assets, and income regulation, thereby shaping economic development.
- It strengthens the financial marketFinancial MarketThe term "financial market" refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces. by providing funds to small-sized enterprises that fulfill the liquidity requirements of NBFCs.
Types of NBFC
The two types of non-banking financial companies are:
- Deposit Accepting: These are the NBFCs that accept deposits from the public, including companies like loan companies, investment companies, asset financeAsset FinanceAsset financing is defined as a loan taken out by an organization using balance sheet assets as collateral, such as land and buildings, vehicles, machinery, trade receivables, and short-term investments. The asset's value is divided into regular payment intervals of the asset's unpaid portion plus interest. companies, etc.
- Non-deposit Accepting: These are the NBFCs that do not accept deposits from the public, and it is allowed only to lend the money to the public and take the repayment against such loans.
Let us now understand the functions of NBFC loans in the financial landscape through the discussion below.
- Providing loans/advances to businesses and other persons.
- Acquisition of various types of securities, such as shares, debenturesDebenturesDebentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. In return, investors are compensated with an interest income for being a creditor to the issuer., bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period., stocks, etc., issued by government authorities, local authorities, or any other type of marketable securities.
- It offers various other services to its customers besides giving loans like currency exchange, underwriting, money market instrumentsMoney Market InstrumentsThe money market is a financial market wherein short-term assets and open-ended funds are traded between institutions and traders., retirement planning, merger activities, etc.
Now that we understand the basics and intricate details of NBFC companies, let us also understand the practical application of the concept through the examples below.
Alastair, a farmer, approached a local Non-Banking Financial Company (NBFC) to secure a loan to expand his agricultural operations. Unlike traditional banks, this NBFC specializes in providing financial services tailored to specific sectors or customer segments. Alastair found that the NBFC offered flexible loan terms and a streamlined application process, catering to the unique needs of farmers like himself.
The NBFC assessed Alastair’s creditworthiness based on his farming experience, crop yields, and projected income rather than relying solely on traditional financial metrics. This personalized approach allowed Alastair to access the funds he needed to purchase new equipment, expand his land holdings, and invest in crop diversification.
Fidelity Investments, a multinational financial service company based in Boston, Massachusetts, is an example of a non-banking financial company, one of the world’s largest asset managers. It provides fund distribution, retirement services, investment advice, cryptocurrency, and insurance facilities, manages mutual funds, and operates a brokerage firm. All the other companies, like mortgage lenders, insurance companies, private equity funds, investment banks, money market funds, hedge funds, P2P lenders, etc., are examples of the NBFC.
The advantages of NBFC loans are as follows.
- NBFC can help in wealth management for stocks and shares.
- They usually provide credit, such as loans and credit facilities.
- They also can issue Commercial papersCommercial PapersCommercial Paper is a money market instrument that is used to obtain short-term funding and is often issued by investment-grade banks and corporations in the form of a promissory note., Certificates of DepositCertificates Of DepositA certificate of deposit (CD) is an investment instrument mostly issued by banks, requiring investors to lock in funds for a fixed term to earn high returns. CDs essentially require investors to set aside their savings and leave them untouched for a fixed period., bankers’ agreements, etc.
- NBFC can substitute the bank in case the banks are not helpful.
The disadvantages of NBFC companies are as follows:
- Non-banking financial companies are not allowed to take deposits payable in demand.
- The restrictions around NBFC are more stringent when compared to the bank.
- Only those NBFCs registered under the appropriate Act and authorized may accept deposits from the public.
- The deposits received from the public are not insured. Hence, there is less security for the deposits compared to the banks.
- It is not allowed to make payments or do settlements for its customers.
- It cannot issue the cheques drawn on it.
NBFC vs Banks
NBFCs and banks differ from each other on various parameters, and some of the differences are as follows:
- Non-banking financial companies cannot accept demand deposits from the public. It can accept only deposits payable at the end of the tenure, whereas banks can accept all types of deposits from the public, both payable on demand and at the end of the tenure.
- An NBFC cannot engage in payments by its customer to the third party on their behalf, whereas banks can permit their customer to pay by way of issuing checkbooks.
- The deposits carried by NBFC don’t have insurance, whereas the deposits with banks carry insurance.
This article has been a guide to Full Form of NBFC i.e (Non-Banking Financial Companies). Here we discuss types, functions, examples & compare them with banks. You may refer to the following articles to learn more about finance: –