NBFCs and banks: How are they different?

Date : 24/07/2020
Read: 5 mins

NBFCs and banks perform similar functions, but differ in many ways. Read on to find out the difference between banks and NBFC.

NBFCs and banks: How are they different?

Banks and Non-Banking Financial Company (NBFC) have many overlapping functions and offer similar products. This leads many people to use the terms interchangeably. However, the two are very different entities, with different structures, payment schedules, and more.

Let us understand the differences between these two financial systems that contribute heavily to the country’s economy.

What makes NBFCs different from banks?

Its very name indicates that NBFCs are different entities from banks. NBFCs are registered under the Companies Act,1956, and provide banking services to people – without holding a banking license.

All non-bank financial entities are classified as NBFCs. This includes investment banks, mortgage lenders, money market funds, insurance companies, hedge funds, private equity funds, P2P lenders, etc. Services provided by NBFCs include home loans, education loans, gold loans, and vehicle loans. NBFCs cannot offer basic banking services like savings/ current accounts, draw cheques on itself or issue demand drafts.

Banks, by definition, are financial intermediaries that provide banking services to the public. They are registered under the Banking Regulation Act, 1949. They can include commercial banks, scheduled banks, and retail banks.

However, both NBFCs and banks are regulated by Reserve Bank of India (RBI).

Why are there two systems?

We have two distinct banking systems because they cater to different needs and sets of customers. NBFCs cater to those whom banks do not usually cover. They provide heavily to infrastructure companies. They also cater to several micro, small, and medium enterprises who may not be covered by banks.

At present, only 34 per cent of Indians are covered by banks. It is the NBFC sector that covers the majority of the country’s loan requirements.

NBFCs provide a range of small-ticket loans for housing projects and various ventures. They provide loans in sectors and sizes that banks would normally not venture into. Rural and small-town India borrow in limited amounts, and it’s NBFCs that play a critical role in the functioning of the economy.

Banks, on the other hand, abide strictly by Reserve Bank of India rules. They lend and borrow based on specific criteria.

How do the two systems operate?

Banks take deposits from the public and lend at market-driven interest rates. NBFCs cannot open savings accounts or current accounts as they do not have a banking license. So, they borrow from banks and sell commercial papers. These commercial papers are short-term financial securities and are usually bought by debt mutual funds.

New age fintech NBFCs also work as account aggregators. With the consent of the customers, they collate and analyze financial data using complex algorithms and Artificial Intelligence. They cross reference the customer data points with different lender’s parameters to find the right fit. They present the customer’s creditworthiness, cash flows, borrowing capacity, possible collateral to place and try and connect these borrowers to right lenders.

Is one faster than the other?

Since NBFCs do not work with public savings, they are also subject to fewer rules and less scrutiny. So, they do not require as much documentation to process loans. Since many small-scale industry owners and rural entrepreneurs do not have the right papers, the system suits them well. Some NBFCs may also have an exclusive mandate to operate in a specific sector – like agriculture. They may offer finance against agricultural assets such as land and produce, along with loans for agri-equipment, machinery and working capital.

Banks need to be highly compliant. Hence, getting a loan from a bank requires one to have multiple documents, KYC checks, past returns etc.

What are the other major differences?

Payment and settlement cycle: NBFCs do not take part in the payment and settlement cycle as they do not take money from the public.

Self-drawn cheques: NBFCs cannot issue cheques drawn on itself whereas banks can.

Demand deposits: Demand deposits are repayable on demand. NBFCs do not accept demand deposits from the public, nor do they accept short-term securities. One cannot withdraw money from an NBFC without prior notice. Banks, however, can take demand deposits and allow their withdrawal. They can also issue safely drawn cheques.

Credit cards and cheque books: NBFCs cannot issue credit cards or cheque books. Banks, on the other hand, can issue credit cards and cheques as they hold a banking license.[SS3][S4]

CRR and SLR: Banks are required to maintain reserves such as CRR (cash reserve ratio) or SLR (statutory liquidity ratio) since they deal with public money. NBFCs do not need to maintain such cash reserves.

Deposit insurance facility: Deposit insurance is readily available to bank customers. The facility is given by the Deposit Insurance and Credit Guarantee Corporation (DICGC). There is no such insurance available from NBFCs.

These are the main differences between banks and the NBFC sector. Knowing the differences and similarities can help you pick the right product for your need and budget. Have a look at how NBFCs can use Aadhar-based bank KYC to give loans.